Are you keeping track of your startup's financial metrics? For any growing tech startup, being able to calculate runway accurately and reduce burn rate are critical components of success. Unfortunately, for most early-stage startup teams, it's not unusual for them to quickly burn through cash without realizing the true extent of their spending. Before long, funds dry up and team members are left scratching their heads.
"The current startup climate doesn't encourage financial restraint," advises Helaine Olen, contributor at Inc. "Companies like Uber and Airbnb have been generously rewarded with market share and growing revenue despite (or perhaps because of) their lavish burn rates. But we're starting to see high rollers falter: Consider the founders of the late housekeeping service Homejoy, who spent $40 million in venture funds only to discover they couldn't clean up in the on-demand economy."
To help you avoid making the same costly mistake, we've outlined a few simple strategies to help you better calculate startup runway, reduce burn rate, and scale like a tech superstar.
Simple Strategies to Calculate Startup Runway, Reduce Burn Rate, and Scale Like a Boss
Homejoy was positioned to join Uber and Airbnb in the multi-billion dollar on-demand and sharing economy. Founded in 2012, Homejoy raised a $38 million funding round in just over a year. Fast forward to 2015, Homejoy closed its doors. The next day, Google hired its entire product and engineering team.
"What's bizarre about Homejoy, though, is the abruptness of its failure given the promise of its industry and the strong team it assembled," says Alex Moazed, Founder and CEO of Applico. Home cleaning represents an estimated $400 billion and Homejoy's team of industry-leading product developers and engineers was considered to be one of the best in the world.
In less than two years, the company's growth stifled, and the leadership team suddenly announced that they had run out of money. Months after the company folded, journalists pointed to worker classification lawsuits that plagued the company to the very end.
"Like Uber, TaskRabbit, and other well-known on-demand economy companies, Homejoy treated its cleaners as independent contractors, and not employees, despite how many hours they worked," says Moazed. "Some litigators did not agree with this assessment, arguing that Homejoy and its ilk were depriving workers of reimbursements and overtime wages."
These lawsuits may have put the nail in the coffin. However, according to senior staff members, the real issue was the cost of user acquisition. The company pumped money into paid channels and offered steep discounts to incentivize customers to sign up. Unfortunately, this spelled disaster for the young company.
What can your startup do to avoid running into the same cash crisis? Follow these simple steps to calculate startup runway and reduce burn rate:
1. Define Your Startup's Gross Revenue
2. Document Your Startup's Total Expenses
3. Subtract Total Expenses From Revenue to Get Profits
4. Calculate Average "Burn Rate" (Dollars/Month)
5. Look for Ways to Reduce Expenditure
How to Reduce Burn Rate
The first step to stifle expenditure and reduce burn rate is to set very clear goals for every team member. Additionally, team members should follow expense approval guidelines. This is critical because all team members should know the top priorities of the company, and focus all of their efforts on achieving those goals. If the startup is sophisticated enough, its accounting tool could build in rules to auto-enforce expenditure guidelines. These practices will encourage teams to cut down on unnecessary spending.
Additionally, growing startups should avoid:
Hiring Staff Prematurely: Before making any hiring decisions, it's important to assess your startup's needs accurately. Do you have a fully fleshed Minimal Viable Product (MVP)? Are you getting in front of enough prospects to determine demand with precision? What expertise do you need right now to get to the next step in your overall growth plan?
Securing Funding Before Clients: Before seeking venture capital investment, learn more about your customers' preferences through product prototyping, informal focus groups, and surveys. Use these findings to create a hyper-targeted product that addresses customers' wants and needs.
Forming Bad Partnerships: Startups should find corporate partners that understand the startup's long-term vision. Has the corporate partner already accomplished something in the same sector? Does the startup have something to gain by joining forces?
Choosing the Wrong Work Environment: The best way to keep costs down is to seek shared office space. There, entrepreneurs can access flexible lease agreements and supportive communities conducive to entrepreneurial growth.
Scale Your Startup Like a Boss
Founding a company requires careful financial planning and management. Without a keen understanding of startup runway and burn rate, entrepreneurs run the risk of creating a financial disaster. RocketSpace provides Seed to Series B tech startups with access to growth-oriented resources, valuable programming and workshops, next generation amenities, and more.
RocketSpace members lean on one another to learn and tackle the tech industry's biggest challenges. If you're struggling to calculate startup runway and reduce burn rate, there is someone here to point you in the right direction. Is RocketSpace right for your tech startup or scale-up?