Critical Financial Term for the Entrepreneur: Burn Rate

 

Burn Rate
Keeping your burn rate low is critical for long term success

The most important financial term to understand in entrepreneurship is the “burn rate”.  The burn rate is your outgoing expenses every month.  If your web hosting costs are $100 per month, your salaries $15,000 per month and your rent $2,000 per month than your “burn rate” would be $17,100 per month.

The lower the burn rate you can have the better.  As the optimistic entrepreneur some of my biggest “weaknesses” has been having too high a burn rate.  As I was always convinced that the money was going to come in I let the costs grow.  The money though always takes longer to come in than you expect.  And your burn rate continues to burn while your clients are not coming in.  At a burn rate of $17,100 per month and a major client delays signing a big contract by three months and suddenly you have had to finance $51,300.  If your burn rate was only $3,000 per month though than you would only have to finance out $9,000.  Customers are often slow at paying too – I once had a fortune 500 company owe me $50,000 and was over 4 months late in paying – this almost put me out of business.  Cash flow is the major reason that startups fail.

Reducing Burn Rate

So how can you reduce your burn rate?  For me the biggest factor in reducing the company burn rate has been having a job or consulting gig.  My ability to earn through consulting in the marketplace was a lot higher than experimenting or building software or ideas in the short term.  This than enabled me to hire more junior people at lower salaries in a different part of the world to work full-time on my ideas while I got the cash in by selling my time working for someone else to finance the business.  You too can drastically reduce your burn rate by keeping your day job and working on your ideas in the evenings and weekends.  As soon as you go full-time you need to add your own salary to the burn rate as you will also have to pay your own house rent and other living expenses.  A job gives you steady cash flow.

Just don’t forget though you will never become rich through a job and selling your time for money always has its limits – so do remember to focus on getting out of the rat race and developing your ideas/business on the side.  It’s tough having two jobs but if you are committed you will have to do this for a while until you are sure you have the cash flow to leave your secure job.

Unfortunately at times you will have to let staff go in order to reduce your burn rate.  Or move into a shoe-box apartment or a friend’s couch and eat canned tuna sandwiches for a while to reduce your burn rate (unfortunately have had to do all of these at various points of launching my businesses).  Hold off on registering your company as long as possible as well.  In the United Kingdom or United States a new business can be as lower than $200 to setup.  In the United Arab Emirates though it can be higher than $7,000 and then the monthly expenses start to pile up and if you are not earning revenue in the meantime you are wasting money that could be better spent somewhere else.

Luckily for you though, starting a company now is cheaper than ever.  Twenty years ago you needed a higher burn rate to start your company.  You needed an office space.  You needed a business phone line.  You needed a secretary to answer the phones.  You needed to market your products and services through the newspapers or radio.  Now you can start marketing your products and services to your friends through facebook or YouTube.  You can get going by having your mobile number be your business contact number.  You can hire cheaper staff through odesk or elance based in a different part of the world with cheaper salaries.  Or better yet – don’t hire any staff at all if you can help it.

When I had my business in London I had a prestigious “18 Soho Square, London W1D 3QL” address which I got through a virtual office for under $150 per month (I used MWBEX as they had the coolest address for my target audience of marketers but there are other companies such as Regus that offer the same service).  This gave my customers such as Google, Intel, Oracle, Samsung and Xbox the idea that I was an important marketing company in a prestigious downtown location while I never had an office but had my business out of my bedroom instead.  If the client ever wanted to visit I managed to take them out to lunch instead, they never minded the free food while I saved costs on paying rent and other bills.  Now though it is becoming more acceptable for entrepreneurs to work from home.

Virtual Offices also give you meeting rooms for rent by the hour.  In the UAE I use a service called http://www.signature.ae/ which answers the phone in the company’s name before transferring the call to me.  It looks more professional than having a mobile number: (you can call me now to see this work during the office hours – as my “secretary” answers +971 4 311 6863).  This costs $110 per month and is better for me than losing a lead.  For the United States you can use a service such as www.grasshopper.com starting at $10 per month to give you a US based number with all the funky “press 1 for sales, press 2 for accounts” and have everything divert to you.  The UK has similar services such as http://www.eoffice.net/virtual_office/Virtual_office.html.

The cool thing about all these services is that you can be based and run your company out of Afghanistan or Kenya and yet your customers believe you are sitting in New York or London.  Countries such as Pakistan have a major branding issue but with these types of services they can compete globally without being discriminated against (high tech startup from Islamabad is not going to sell as well as a high tech startup from San Francisco).  If you really want to hide your country than name yourself “Steve” or “Lisa” when answering your phones – gets a better conversion rate than “Abdulla” or “Fatima” (unfortunately “brandism” exists and as a marketer that continually tests these things I can tell you that your country will impact your wealth – these simple tricks of the trade though will help you get rid of any discrimination).

Do not invest in the most reliable high end servers to get you started.  Use shared hosting which starts at $7 per month instead.  It will take you much longer to get that server crashing traffic that you are expecting than you think.  If you have a choice go for OpenSource (PhP) rather than Microsoft’s ASP platforms for your coding.  Microsoft hosting costs begin to add up even if you are using the illegal copies of their software which many of the developing countries do.  Linux is cheaper and often more reliable.

You will need to be creative in reducing your burn rate as unfortunately business almost always takes longer than you planned to get off the ground.  Those hockey stick figures that you show on your business plan is for the investors and the dreamers – real life will usually be slower than what your “conservative” business plan shows (entrepreneurs always claim the numbers they are showing for growth are on the conservative side and they genuinely believe it too).  The facebook or google growth numbers happen once or twice a decade and hate to break it to you but chances are it’s not going to be your company.  The numbers those “internet marketing gurus” tell you about how they work less than two hours a day on the beach and make tons of money is probably not for you either – unfortunately you will have to put a LOT more hours in and get a LOT less returns than what the internet products training claim.

When you first start your online business your mind gets filled with big dreams and big dollar signs that if only 0.1 % of the two billion people that are online use your product/service than you will make x zillion dollars in 5 months.  So you let your costs grow as you think that “you have to spend money to make money”. But the truth is there are millions of websites competing for people’s attention and so your growth is likely to be a lot slower than expected.

Focus on reducing your burn rate so that when the money does finally roll in your business is ready to use it wisely to grow to the next level.  Business is a long journey and hardly ever an “overnight success”.


About the Author

Amir Anzur

3 Comments

  1. Thanks for the great insights on how to keep your startup lean. Another important thing about keeping the “burn rate” low is that as an entrepreneur you have to be able to change directions and try different approaches. If you are weighed down by unnecessary expenses, you will be much less agile.

  2. Nice weblog! Plenty of helpful information here. I was looking for this.Thanks for sharing!

  3. Hi, Magnificent site. Some truly wonderful posts on this blog, thank you for contribution.

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