KEEPING A STARTUP’S BURN RATE UNDER CONTROL.
Before Adam Jarczyn and his three co-founders sold their startup Hover to Slyce in November 2013, they were running a pretty tight ship. None of them took a salary until four months before the acquisition. Spending was negligible for the first five months of the company’s 16-month life — sourced mostly from poker winnings — until they had real money to spend, in the form of a $50,000 grant from the government’s Industrial Research Assistance Program (IRAP).
It was in those early days that the team learned a few valuable lessons from operating on such a paltry budget. They thought more strategically about milestones, for one, and not getting carried away with unrealistic valuations. It’s a scenario that rings true for the majority of startups, even if there isn’t one prescribed method to prioritize expenses and make cash last until more financing appears.
Eventually, Hover procured more government money, $30,000 from Venture Start, and an aggregated $120,000 from angels. During the first three months of 2013, they burned through nearly half of the collective sum. The remaining $100,000 stretched over the next eight months, resulting in an average burn rate of about $10,000 a month.
When there was something to show in the coffers, the team would gather around a white board and chalk out spending projections. “It forced you to take the time to do it, which is good, because you’re dead clear on how you’re going to spend that money,” Jarczyn said.
Even if his team wanted to blow cash recklessly, Jarczyn said, they couldn’t because of spending rules tied to the government money. IRAP needed to see an expense plan and required the funds be spent in a designated period and only on technical staff; at Venture Start, a sponsor had to sign off on their business plan.
The sponsor didn’t follow a textbook solution for how to spend, or how quickly. But he did take stock in mapping out a spending plan, to avoid the devastating, often fatal, consequences of bungling the burn rate.
Kevin Sandhu, chief executive of Grouplend, said he broke down his startup’s spending into phases. In the initial stage, before he raised any money, he was paying costs out of his pocket and each expense line was scrutinized carefully while the team built its software.
Frugality was essential in the early days, which meant opting out of an office lease and hiring freelance workers for specific tasks to avoid keeping on permanent staff that might go underutilized, he said.
“Every time we spent a dollar, the question was, ‘Does this help us build our technology, or get us regulatory approval?’ If it doesn’t, we shelf it,” Sandhu said.
Just before Grouplend’s launch last October, Sandhu acquired a small amount of financing, and his goals changed. The startup needed a proper office space, a marketing budget and a bigger team. Predictably, the startup’s burn rate accelerated, from a pre-launch sub-$10,000 range to eclipsing $100,000.
Fresh off a $10-million Series A round in August, Sandhu said he’s ready for growth. Even if it’s too soon to predict what this next phase will look like, Sandhu plans to double his team twice — once this year, and again in 2016 — and move them into a more upscale workspace.
Jarczyn said these are expenses that were out of reach when he was running Hover, although he put significant thought into what he’d do if he had the cash.
“Later you learn that raising money is about how to grow, not how to keep your lights on. But there’s a grey area in there depending on how much you’re raising,” Jarczyn said.
“If you raise a ton of money for growth, you double or triple your head count and you go (ahead). If you only raise a small amount, then the goal is to keep the lights on.”
No matter how much money is in the coffers, many founders argue that employees are the biggest expense. Carol Leaman, a serial entrepreneur and chief executive of Waterloo, Ont.-based elearning company Axonify, said the average cost per hire is about $100,000. Jeff Lawrence, the CEO of Granify, who has raised $8.5 million in three rounds, said approximately 90 per cent of his spending goes toward head count.
“The human cost is typically the biggest burn item. It’s not servers, it’s not an aggressive marketing experiment,” said Marcus Daniels, Highline co-founder and chief executive.
Leaman says people underestimate the true cost of human capital, which includes payroll taxes, health benefits and ways to enhance workplace culture.
In theory, more staff is supposed to equate to growth, but a rise in revenue isn’t necessarily immediate. Granify’s time as a cash-flow-positive startup was short-lived, after it doubled its payroll to 30 people following its Series A in May. Call it growing pains, but now, Lawrence said, the Edmonton-based startup is playing catch-up to get to its revenue goal of $10 million next year.
Grouplend’s Sandhu is budgeting at least a third of the latest round to build his team. He said revenue growth for the online lender will need to be twice as high as its burn rate, until expenses decline and the company is cash-flowpositive.
“We have very specific targets around that. If we’re not hitting them, we have to sit down and think about how to cut some expenses to reduce the burn rate,” said Sandhu, who has worked in private equity handing money to startup founders.
Things go wrong both when there there’s a lack of specific targets in place, and when a founder team adheres so strictly to them that it fails to evaluate factors beyond predictive models, Leaman said. Common errors she cited include hiring staff too soon and underestimating hidden expenses such as travel. “There are little leakages that can start to happen that come from the entrepreneur feeling a bit flush and also some pressure to spend money,” she said.
First-time entrepreneurs in particular have a hard time evaluating how long it’s going to take to hit revenue milestones, she said, causing prospective investors, who, in the early stages might be sympathetic, to eventually tune out as a startup runs out of cash.
But Jarczyn contends, having limited capital can be a blessing in disguise. “When you have a small amount of money, you’re forced to make strategic decisions. (It) helps you learn the lessons a lot faster.”