Understanding the Burn Multiple - Introduced by David Sacks

The Burn Multiple, as conceptualized by David Sacks, is a straightforward yet powerful tool to measure capital efficiency. It can be contrasted with other metrics like the Hype Ratio and Bessemer’s Efficiency Score:

• Hype Ratio: Capital Raised (or Burned) / ARR

• Efficiency Score: Net New ARR / Net Burn

However, the Burn Multiple refines this approach by flipping the Efficiency Score’s formula:

• Burn Multiple: Net Burn / Net New ARR

This metric shifts the focus directly onto the burn rate, evaluating it as a multiple of revenue growth. It essentially asks: How much is the startup burning to generate each incremental dollar of Annual Recurring Revenue (ARR)?

A high Burn Multiple indicates that the startup is spending a lot to achieve each unit of growth, while a lower multiple suggests more efficient growth.

Practical Insights from the Burn Multiple

For venture-stage startups, the Burn Multiple serves as an insightful and practical benchmark. It's an effective way to judge whether the burn rate is appropriate for any given time frame, be it monthly, quarterly, or yearly.

Consider a scenario where a startup reports a $2M burn in a quarter while adding $1M to its ARR. This results in a 2x Burn Multiple, which is considered reasonable for an early-stage startup. In contrast, a 5x Burn Multiple, where $5M is burned to add only $1M of net new ARR, is a red flag indicating a need for immediate cost reduction.

The Burn Multiple as an Indicator of Product-Market Fit

The Burn Multiple can also serve as an indicator of product-market fit. A startup that achieves significant ARR with a lower burn rate is often seen as having a better market pull for its product, compared to one that achieves the same by burning a significantly higher amount.

The Burn Multiple: A Comprehensive Metric

The beauty of the Burn Multiple lies in its ability to act as a catch-all metric. Any significant problem within a startup, be it related to gross margins, sales efficiency, churn, or growth challenges, will eventually be reflected in the Burn Multiple. It does this by affecting either the burn rate, the net new ARR, or both, but at disproportionate rates.

When is a High Burn Multiple Acceptable?

In the early stages of a startup, particularly when sales are nascent and the product is still being developed, a higher Burn Multiple can be more acceptable. This is especially true for startups in their "Wilderness Period," where the focus should be on minimizing burn and achieving the first significant revenue milestones.

Burn Multiple Across Different Stages

As a startup progresses from the seed stage to Series A and B, the expectation is for the Burn Multiple to improve. This improvement is a sign of maturing business operations and increasing sales efficiency. Ultimately, for a startup to reach profitability, the Burn Multiple should trend towards zero.

Actionable Steps for Founders Based on the Burn Multiple

Founders can use the Burn Multiple as a guide to make strategic decisions. Keeping operational costs low in the early days is vital. This not only extends the runway but also strengthens the impression of product-market fit. Importantly, founders can improve their Burn Multiple by reducing costs, as this metric adjusts to the most recent financial period.

In a challenging economic climate, where growth efficiency is as crucial as growth itself, the Burn Multiple, as introduced by David Sacks, provides a valuable metric for founders and investors. It offers a clear perspective on whether a startup's spending is in line with its growth and can reveal deeper insights into the effectiveness of incremental investments. As startups strive to extend their runway and make impactful decisions, the Burn Multiple stands out as a key metric to monitor and optimize.