With rising interest rates, there’s a new sheriff in town for all companies. It’s called efficiency.
Efficiency is now especially important for startups, which are always running fast toward a cliff.
When, as a typical startup, you have immediate death coming at you within 18 to 24 months, it’s really scary. When you reach the edge of that cliff, you either take off — or you don’t. And in this new environment in which interest rates are climbing, access to capital is diminished and investors are “fleeing from the riskiest companies,” meaning nascent companies are in an even more precarious position. They don’t have the luxury of hiring too many people or not the right kinds of people. Such mistakes will only accelerate their move off the cliff and to their deaths.
The gold standard is a burn multiple of one — for every dollar you burn, you add a net new dollar in subscription revenue.
As startups born or growing during the last recession, including Airbnb and Facebook, have proved, efficiency can put you on the fast track to massive success even in hard times. Yet many startups have much higher than necessary burn rates. Just look at Fast, a one-click checkout software startup that burned through $10 million a month. Earlier this year, Fast shut down abruptly after burning through more than $120 million in funding.
Avoiding this fate requires a radically different approach. You now need to ask: How can we slow down the speed at which we reach the cliff of death? Can we turn this into free cash?
Adopting this mindset can be very difficult for a young company to do, especially given the revenue growth demands that venture capitalists require on return. But such thinking is what you need to grow your company efficiently in a recession — and hiring against the burn multiple is a proven way to extend your runway while still achieving lofty growth targets.
Calculate your burn multiple and understand when you need to reduce it
David Sacks, the godfather of the burn multiple, explains that burn multiple is net burn/net new annual recurring revenue (ARR). This ratio addresses how efficiently you are in adding revenue. As Sacks notes, the beauty of the burn multiple is that it’s a catchall metric. You can manage your whole company around it. If you have a churn problem, a growth challenge, a product-market fit issue, it’s all baked into burn multiple. The number doesn’t lie. If you have recurring revenue, burn multiple is the gold standard for how to evaluate your company.