Janelle van Deventer
Janelle van Deventer
Marketing and Community Manager
Posted on
September 30, 2022
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0
min read

What is Burn Multiple, and how do you calculate it?

What is Burn Multiple, and how do you calculate it?

What is Burn Multiple?

Burn Multiple is a capital efficiency metric. It compares how much annual recurring revenue (ARR) is added with how much cash is spent in a given period, from a month up to a year. Put simply, it measures how many $ a company burns to create $1 of ARR.

It is a particularly useful metric for recurring revenue SaaS businesses. However, it can be used to measure how efficiently any company with a high growth potential generates revenue.

As we’ll refer to ARR and burn rate throughout this article, here’s a recap of what those terms mean:

ARR

The sum of the yearly recurring charge of all paying customers. It is frequently used by subscription businesses with multi-year agreements.

Burn rate

The rate at which a company spends money to finance overhead every month. Companies in technology and startup industries that have a limited amount of time to achieve profitability use it often. A company with a burn rate of $2M is spending $2M per month.

How is Burn Multiple calculated?

It’s a simple calculation that evaluates burn as a multiple of revenue growth.

Burn multiple = Net burn/Net new annual recurring revenue

Net burn is divided by net new ARR for the chosen period, usually a year, a quarter, or a month. The lower the figure that calculation produces, the lower the Burn Multiple. The lower the Burn Multiple, the more efficient the company.

The more money a company burns to achieve a unit of growth, the higher the Burn Multiple. When the Burn Multiple goes below zero, the company is cash flow positive.

Here’s what that looks like in practice.

A start-up burns $30M to add $10M of ARR.

The company’s Burn Multiple is $30M/$10M, giving a Burn Multiple of 3.

$3 have been burned for every $1 gained.

The Burn Multiple is useful for assessing the quality of product-market fit. A company that generates $10M of ARR at a cost of $10M (producing a Burn Multiple of 1) would be more appealing to investors than the one mentioned in the example above, as it has a lower Burn Multiple.

Why is Burn Multiple important now?

Companies with high burn rates that never turned a profit received plenty of funding until recently. Think Uber, WeWork and Klarna, who financed their growth with additional rounds of funding. VCs were happy to bet on companies with high Burn Multiples in the days of ‘growth at any cost’.

Market conditions have changed. The economic downturn has revived interest in the Burn Multiple. Understanding how much money is spent to earn a dollar of ARR has become a key performance indicator. Understanding your Burn Multiple can help you identify opportunities to extend your runway.

Financing partners and VCs are now looking for companies with low Burn Multiples and are potentially willing to pay a premium for companies that balance growth with efficiency.

On the other hand, companies with a high burn rate will find it more difficult to fundraise.

How does Burn Multiple compare to other efficiency scores?

Scores like Lifetime Value (an estimate of the average revenue that a customer will generate throughout their lifespan as a customer) or Customer Acquisition Cost (how much a company has to spend to get a new customer) only focus on sales and marketing costs.

Burn Multiple takes into account costs that occur in every function of a company. Inefficiencies in any area will affect it and make it higher.

These can include:

Spending too much on COGS (cost of goods)

A service or product that is expensive to deliver will lead to a high Burn Multiple.

Inefficient sales

When a company is growing, but the rate at which it is selling its product or service is slowing, the Burn Multiple will rise.

Churn

A company that is not retaining customers will see its Burn Multiple rise as its ARR will remain flat. It is better if existing customers continue to renew their contracts.

Lack of growth

Companies that offer promotions or discounts, or invest in extra marketing to attract new customers will increase their burn rate, and, consequently, their Burn Multiple.

Leadership

If the Burn Multiple remains high over a long period, investors might begin to question the skills of a leader or founder.

What is a ‘good’ Burn Multiple?

David Sacks, a B-stage SaaS investor at Craft Ventures devised the Burn Multiple formula to help assess growth and investment during market downturns. (You can read his 2020 post about it here).

His new Burn Multiple benchmarks for venture-scale startups in 2022 have been widely accepted.

However, different Burn Multiples are acceptable at different stages of growth.

It’s impossible to calculate the Burn Multiple of pre-revenue startups as the ARR is zero.

It is understood that seed-stage companies often have higher Burn Multiples because sales are low and the product is still being built. Keeping salaries and expenses low at this stage can keep the Burn Multiple down.

Investors expect companies in the mid or later stages (Series B, or above) to have a low, or negative Burn Multiple.

Here are indicators of acceptable and outstanding Burn Multiples for companies at each stage of growth.

How can a Burn Multiple be lowered?

A lower Burn Multiple can be achieved in two ways: reducing burn rate, or increasing ARR.

Reducing burn

This is the faster way of bringing down the Burn Multiple, as the formula uses figures from the most recent period. Companies usually improve their margins by reducing headcount, getting out of leases or commercial contracts, or finding ways to lower COGS.

Increasing ARR

Acquiring more customers, increasing the average revenue per user, and reducing churn will lower the Burn Multiple too, in a more desirable way.

A practical way of achieving this includes Lowering CAC (Customer Acquisition Cost). Marketing and sales teams can help identify ways of shrinking the cost of acquiring a new customer, reducing the length of time they take to start contributing to profits.

Final thoughts

This article has covered what you need to know about the Burn Multiple, a metric that measures how efficiently a company is growing and how effectively it is functioning as a whole.

It has become increasingly important to founders and investors during this economic downturn as it becomes harder to fuel growth by fresh funding rounds alone.

But if your company’s Burn Multiple is higher than you’d like right now, don’t be discouraged. It is completely normal for early-stage companies to have a high Burn Multiple. There are plenty of financing options available for SaaS companies like yours.