A lot is said about startups, and the main ones are called “unicorns.” Some most famous startups are Airbnb, SpaceX, Stripe, and Klarma. We already know that startups have different challenges, but certainly, there is one major dilemma: the definition of burning cash or going to break even. In this post, we will explore some of these concepts and why they are considered essential dilemmas for startups.
The startup world
The concept of startups differs from person to person as it is a new term in the market. According to the Forbes Advisor, startups are businesses that want to disrupt industries and change the world — and do it all at scale. Startup founders dream of giving society something it needs but hasn’t created — generating eye-popping valuations that lead to an initial public offering (IPO) and an astronomical return on investment.
As every business startups need a product/service, a team to run this business, and of course, money. With a disruptive mindset, the team will be responsible for defining the growth strategies, and that’s when the famous dilemma comes. Are we seeking first for break-even, or should we burn cash to grow disruptively?
What does it mean to “burn cash”?
This term is not well widespread as “break-even.” and it is most common among financers, but in a nutshell, cash burn is the speed at which a company spends the money that is available to it when it is not making more money than it spends. Thinking about startups, new businesses require investments; it could be people, research, development, or marketing. It is very common for startups in a growth state to “burn cash,” If that’s the case, one of the most important metrics to keep in mind is the burn rate.
Let’s pretend you are the owner of a B2B Startup selling a SaaS product. You’ve just validated it with the first client, have some proposals on the table to get the second one, and there is an investment fund approval. You decided to allocate this money to marketing campaigns and product development.
To calculate the cash burn rate, consider your total costs and revenue. For example, if your startup spends $10,000 every month on office space, computers, and wages, but sales only amount to $8,000 in that same month, then your burn rate is $2,000 ($10,000 – $8,000). Another way to look at this is to consider the cash available and compare it with your monthly expenses:
Gross Burn Rate = Cash / Monthly Operating Expenses
Gross Burn Rate = $100,000 / $10,000
Gross Burn Rate = 10
That number tells you that, without any income or changes in expenses, you have enough money to pay your bills for 10 months.
And what does it mean to break even?
Break-even also relates to the total costs you have and your revenue, but the analysis here is: how much money you need to cover all your expenses. You can also think of how many units or contracts you need to cover all your costs, and this number will represent your break-even point.
Calculating break even is as simple as cash burn. Using the last example, if your startup spends $10,000 monthly on office space, your break-even will happen when you achieve $10,000 in sales revenue ($10,000 – $10,000 = 0). In this case, you paid all your costs with the revenue you were able to generate in that month.
It can be more complicated when you have your SaaS product at a fixed price. Let’s pretend your monthly revenue from a contract is $45,8, and your costs for the month are $10,000. How many contracts do you need to break even?
45,8x = 10,000
10,000/45,8 = 218,34
In this case, you cannot assume that 218 contracts will achieve your break-even; for this analysis, the decimals always matter, and you have to round up – ALWAYS! The correct answer would be 219 contracts in monthly recurring revenue of $45,8 each.
The startup dilemma
Startups need investments. If you are starting a business, you will probably be far away from your break even. However, depending on how your sales go, you will have to make a decision – is it time to seek break-even or burn cash to accelerate growth? This dilemma depends on the strategy, the structure, and mainly, what the board of directors and investors want.
However, understanding the relationship and mastering these numbers is crucial: If you’re burning through $100,000 a month, it’s going to take a significant amount of revenue just to break even. It’s also going to take substantial capital to keep your business afloat until it can turn a profit.
In the end, there is no right or wrong answer; it is always related to your business strategy, and the risks you are willing to take – for sure, seeking to break even is a safer route, but there are different profiles out there, and taking the risk of a high cash burn can also accelerate a business and bring significant impact in the long run.