- Hype Ratio = Capital Raised (or Burned) / ARR
- Efficiency Score = Net New ARR / Net Burn
David think Bessemer has the right idea but prefers to flip the numerator and denominator, so the ratio is an annualized version of the Hype Ratio.
He calls this the Burn Multiple:Burn Multiple = Net Burn / Net New ARR
In other words, how much is the startup burning in order to generate each incremental dollar of ARR?
The higher the Burn Multiple, the more the startup is burning to achieve each unit of growth.
The lower the Burn Multiple, the more efficient the growth is.
For venture-stage startups, these are reasonably good rules of thumb:
For example, Q1 just ended and it’s time for a board meeting. The startup reports that it burned $2M in the quarter while adding $1M to its ARR. That’s a 2x Burn Multiple — reasonable for an early-stage startup. On the other hand, if the company burned $5M in Q1 to add $1M of net new ARR, that’s a terrible Burn Multiple (5x). It should probably cut costs immediately. That company is spending like a later-stage company without delivering later-stage growth.
Too many startups report their growth without contextualizing it as a function of investment. If extraordinary investment (3x burn or more) is required to deliver that growth, it’s an indicator that product-market fit isn’t quite what it appears to be or there’s some other problem in the business
These are some of the things that can affect the burn multiple and your business
For example:
- A gross margin problem — If the company spends too much on COGS in order to deliver the product or service, its burn will increase rapidly as it scales. If there’s not operating leverage in the business, the Burn Multiple will not improve with scale.
- A sales efficiency problem — If CAC is prohibitive or sales productivity is diminishing, burn will increase relative to new ARR, causing the Burn Multiple to worsen even though growth continues.
- A churn problem — Churn will net against the denominator of the Burn Multiple, causing the multiple to increase. A leaky bucket makes it hard to grow efficiently.
- A growth challenge — If growth is stalling, the company may seek to compensate by spending more on marketing, give-aways, discounts, or promotions. That will be picked up in a higher Burn Multiple, as burn rises faster than new sales.
- A founder leadership problem — If the founder lacks the skill or will to control burn, that will show through in the Burn Multiple.
Burn Multiple by Stage
The Burn Multiple should improve as the startup matures.
For example, a seed stage company might have a Burn Multiple of 3 because it just started selling. After the Series A, it might drop to 2. After the Series B, when the sales team should be operating at scale, the expectations for efficiency increase even more.
Eventually, for a company to become profitable, burn must reach 0, which implies that the Burn Multiple should also approach 0 over time.
If the Burn Multiple is going in the wrong direction as the startup matures, that’s a indicator that something is wrong, even though headline growth might still be increasing in nominal terms.
What Founders Can Do
1. they should keep salaries and expenses low in the early days —
2. strengthen the impression of product-market fit for when they go out to raise a venture round.
3. cut costs, the Burn Multiple doesn’t care about sunk costs and always gives founders the chance to improve.
4. It be worth giving up some revenue (e.g. unprofitable growth) if it brings the Burn Multiple down to a much healthier ratio.
It’s not just about growth but the efficiency of growth .
It’s an indicator that incremental spend is working
As everyone in the startup ecosystem scrutinizes their runway and makes tough decisions about how to extend it, the Burn Multiple is a useful rule of thumb for founders and investors alike to keep in mind.
