Psst…Have you heard of the Burn Multiple?
In our May edition of ALL STAR SAAS FUND monthly roundup, our partners Hiro, Masa and Tatsuya share more about the Burn Multiple and why it is an important multiple for Japan SaaS startups. Tune in to the full discussion in Japanese here, but if you would like a quick summary, keep reading!
In short, the Burn Multiple is calculated as the net burn (or how much cash is being used) divided by the net new Annual Recurring Revenue (ARR). For example, if a company burned $3 million USD in the past 12 months but they have an increase in their ARR of $1 million, they have a Burn Multiple of 3. If they had burned $1 million instead, that would mean a multiple of 1.
This is usually calculated based on the total numbers for a company’s past 12 months because doing this per month will lead to very volatile numbers.
Here’s a simple example of how we might compare Burn Multiple ranges:
However, given the volatile funding landscape now, there could be future changes in capital markets’ attitudes which will result in changes in the “acceptable ranges'' for Burn Multiples. Therefore, it is important for startups to regularly keep tabs on their own growth and engage actively with investors to maintain alignment on what is acceptable.
It is also important to note that Burn Multiples should be viewed alongside a company’s growth rate. If a company has an exponential growth rate, the acceptable range of the Burn Multiple naturally increases. Similarly, a company with less than 100% growth rate would have a smaller, acceptable Burn Multiple range. Therefore, while a company with 200% growth rate would be perfectly fine in the upper range of “Good”, a company with less than 100% growth rate should aim for “Great” instead.
Masa shares his thoughts why.
“The Burn Multiple only becomes a factor when a company is growing. Therefore, it is also important to assess the quality and actual breakdown of the multiple.”
Source: Scaling to $100 Million by Mary D'Onofrio and Ethan Ding
|
For instance, a SaaS company expanding vertically will probably end up launching multiple products. It’s probably not a good sign if such a company is pumping cash solely into sales and marketing without doing R&D, as we can probably expect their growth rates to be stunted in the future. Instead, we can consider one other benchmark that American VC Bessemer suggested - the “scale to $100 million ARR” (as shown in the table above). They suggest that a company growing by 200% annually would probably want their sales and marketing expenditure to be 95% of - or around equal to - their overall revenues, with expenditure on R&D being at around the same level at 95% of revenue. This is one way of really scrutinizing the Burn Multiple, instead of just relying on the figure itself. |
Market conditions may not be great right now and many startups are worrying about funding. The gap in PSR (Price to Sales Ratio) between public companies on the Japanese stock markets and pre-IPO companies has also widened tremendously, with the PSR ratios of public companies plummeting. Typically, PSRs are used to calculate a SaaS startup’s valuation and can be an indicator of a company’s projected growth over the next 12 months.
Therefore, given poor market sentiments, it is increasingly important that companies are evaluated in a way congruent to current market conditions and for them to avoid having to face a funding down round.
Startups also have to start making judgment calls on whether they should trade growth for runway or they should keep chasing growth single-mindedly, given that growth rates traditionally have a huge impact on how they are evaluated by the capital markets.
This is where the Burn Multiple could come in handy because it could be used as an indicator of efficient growth versus normal growth and help startups get evaluated in a more holistic manner under current market conditions. Tatsuya shares an example of how this can be done.
“I think that the Burn Multiple is actually an extremely important indicator of Product Market Fit.”
|
Capital markets, especially for public companies, have become far tighter. But if investors use this to tighten their wallets and startups follow by tightening their spending and slowing growth, then I really feel that the benefits of being a startup really weaken. I think that there is a need to economize, and, for example, cut marketing strategies which aren’t producing a good ROI. But I also think that startups should continue to invest in R&D, sales and marketing, engineer hiring etc. to improve their Monthly and Annual Recurring Revenues respectively. In particular, those which have already reached Product Market Fit should continue to use these growth rates to appeal to investors. For me, I think Product Market Fit should be the overwhelming focus of Seed-stage startups. Series A startups need to focus on lowering churn. Series B and later startups should be looking at lowering the Customer Acquisition Cost payback period and increasing sales efficiency etc. In that sense, the Burn Multiple is an overall indice. Nonetheless, a poor Burn Multiple could still be a sign that the product hasn’t really found its market fit yet. |
In addition to reviewing the numbers and quality of the Burn Multiple, startups should also calculate how many more months they have as a runway before they run out of cash. This would be crucial in helping startups find the right balance between chasing growth and maintaining a healthy runway.
Lastly, for startups invested in by angel investors or VCs, it is equally important to get clear alignment regarding pace of growth and not be satisfied with just a low Burn Multiple.
After all, startups with a good runway, clear growth strategy and strong growth rate will have no issues fundraising - and knowing this would give many startups the sense of security needed to plan ahead!
“One message that I want to convey to everyone is that while we see in the news that the market and investment outlooks are gloomy, I personally think that the changes that we are seeing are positive.”
|
One thing is that, well, the “bad conditions” that we are experiencing won’t go on forever. The fact that multiples are going down for public companies doesn’t really affect people who are starting their companies this year or those who have early-stage startups. You’d be going public probably like 5-10 years from now after all. When looking at things in this time span, the market correction that we are seeing isn’t actually a bad thing. I also think that this is a good year for people to start their companies since things can only go up from here. Things could continue to go down, but there’s only limited room for conditions to further worsen and I expect things to improve within 2-3 years. Therefore, it’s actually not a bad idea to start your company now to take advantage of the rebound! |