Interpreting the Burn Multiple
The following rules are used to interpret a startup’s burn multiple:
- High Burn Multiple → The higher the burn multiple, the less efficient the startup is at achieving each incremental step of revenue growth.
- Low Burn Multiple → On the other hand, a lower burn multiple is preferred because it implies the startup’s revenue is generated more efficiently.
Burn Multiple Chart (Source: David Sacks)
Startups with low burn multiples in theory should have more runway and be capable of withstanding an economic downturn, which practically all existing and potential investors would perceive positively.
In contrast, the growth of certain startups can be overly reliant on the continued injection of outside capital from investors.
But if access to capital were to end – i.e. existing or new venture capital firms were no longer willing to provide capital to fund growth – the startup’s unsustainable burn rate and low margins would likely soon catch up to them.
While growth often requires significant reinvestments and capital expenditures, startups with a substantial burn rate relative to their growth cannot support such a continued pace of spending, putting the startup in an unfavorable position of constantly needing to raise capital.
These sorts of startups should begin cost-cutting efforts immediately and work on improving their operational efficiency, especially if a slow-down in performance is expected.
The burn multiples of early-stage startups will typically improve and gradually approach zero as they mature. But once the burn multiple does reach zero, this implies that the previously unprofitable startup is now turning a profit.
Causes of High Burn Multiple
The common causes of a high burn multiple include:
- Inefficient Sales and Marketing (S&M) Strategy
- Misallocation of Capital, i.e. Low Return on Invested Capital (ROIC)
- Inability to Scale from Low Gross Margin
- Low Sales Productivity
- High Customer (and Revenue) Churn Rates
Burn Multiple – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Burn Multiple Example Calculation
Suppose we’re attempting to evaluate a SaaS startup’s historical growth across the past four years.
While unrealistic, we assume in this exercise that the startup’s net burn remains constant at $10 million per year.
In the annual recurring revenue (ARR) roll-forward, the beginning ARR of our startup is $20 million.
From there, our assumptions for the new ARR, expansion ARR, and churned ARR are as follows.
|Annual Recurring Revenue (ARR)
|Plus: New ARR
|Plus: Expansion ARR
|Less: Churned ARR
The net new ARR is calculated by adding the new ARR to the expansion ARR and then subtracting the churned ARR.
- Net New ARR
- Year 1 = $4 million + $2 million – $1 million = $5 million
- Year 2 = $5 million + $3 million – $1.5 million = $6.5 million
- Year 3 = $6 million + $6 million – $2 million = $10 million
- Year 4 = $10 million + $14 million – $4 million = $20 million
Using those inputs, we can calculate the burn multiple for each year.
- Burn Multiple
- Year 1 = $10 million / $5 million = 2.0x
- Year 2 = $10 million / $6.5 million = 1.5x
- Year 3 = $10 million / $10 million = 1.0x
- Year 4 = = $10 million / $20 million = 0.5x
Our model indicates that the startup is becoming more efficient at generating revenue, as reflected by the declining burn multiple.
From Year 1 to Year 4, the burn multiple dropped from 2.0x to 0.5x – which given our fixed net burn assumption, implies that the startup’s sales efficiency must be improving as it continues to scale.