Understanding burn multiple is key to understanding the efficiency of a SaaS company. It can tell you how effective management is deploying its capital to grow, how well the company is pursuing its goals, and how resilient the company will be in lean times or economic downturns.
What is burn multiple?
Burn multiple defines how efficiently a company uses its capital to create new recurring revenue. It is a metric created by SaaS expert and Craft Ventures founder David Sacks as a way to see how efficiently a company grows, rather than simply how fast they are growing.
In good financial times, when the cost of capital is low, it is easy for companies to focus solely on how fast they can grow, without measuring how much capital they are using for that growth. However, when interest rates increase and the cost of capital rises, investors become more careful with their money and want to see exactly how well it will be spent on growth before they invest it. Burn multiple gives them a way to do that.
How to calculate burn multiple
Burn multiple is a ratio between the net burn and the net new Annual Recurring Revenue (ARR) for a period. It is calculated as follows:
Net burn/Net new ARR = Burn multiple
The “net burn” is the net cash decrease by a company during a period (excluding financing activity). Net new ARR is the amount of new recurring revenue you have after churn. By comparing these two, you can see how efficiently you are bringing new customers into your business that will enable it to be sustainable in the long term.
Alternatively, you could think of it this way: how effective is your business in converting short-term viability (burn rate) into long-term viability (ARR)?
Let’s look at an example. Suppose your business burned $500,000 in the last quarter, and brought on $300,000 in new ARR (after churn and retention). That would look like this:
$500,000/$300,000 = 1.667
This tells you that the company is spending $1.67 for every dollar it brings in new revenue. For an early-stage SaaS company that is still gaining traction in the market, this is not a bad burn multiple. However, if the company was well-established, an investor would like to see a burn multiple less than one, and preferably close to zero.
A well-established SaaS company might have a burn multiple that looks more like this: a net burn of $1M and net new ARR of $2.5M in a quarter.
$1M/$2.5M = 0.4
This burn multiple says that the company is only spending $0.40 for each dollar of new recurring revenue brought into the company. This company is growing efficiently.
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History of burn multiple
The burn multiple originated from two other SaaS metrics: the Hype Factor and Bessemer’s Efficiency Score.
The Hype Factor measures capital raised (or burned) against net new ARR – so named because startups often advertise how much they have raised without demonstrating how the company itself is growing.
Bessemer’s Efficiency Score is essentially the burn multiple reversed. It compares net new ARR to net burn, to get a number that would be the reciprocal of the burn multiple.
In 2020, David Sacks saw these two metrics and created the ratio he termed the burn multiple in order to get a figure that showed essentially the same information as these two ratios in a neater package.
The Hype Ratio is only really effective for startups in the capital-raising stage, whereas the burn multiple is an effective measuring tool for companies at any stage of growth. We can think of the burn multiple as a sort of annualized hype ratio, as it returns the same efficiency score year after year.
Bessemer’s Efficiency Score can show the same information as the burn multiple, but in a slightly more complicated package.
What is a good burn multiple? Benchmarks
According to Sacks, a burn multiple anywhere less than 2 is considered “good” for a venture-stage SaaS company.
Anything above 2 is suspect or dangerous to the long-term health of the enterprise.
For more well-established SaaS companies, it is generally expected that the burn multiple will be less than 1 or negative.
How to improve your burn multiple
The burn multiple can be improved in a number of ways, but it essentially boils down to: decreasing burn rate or increasing net new ARR.
Decrease burn rate
Since the burn rate is a measure of how much money you are spending in a given period, anything you can do to keep expenses low during your growth phase is helpful to reduce the burn rate.
If your startup has not started earning any revenue yet, it is especially important to keep the burn rate as small as possible. This has a double benefit.
First, it keeps your startup viable as long as possible. Second, you show potential investors that you are managing your money well, leading to greater confidence in your startup and the possibility of more funds to invest, keeping your startup going until you begin to earn revenue and enter the growth phase.
Increase new ARR
If you can’t cut expenses without harming growth, the other way to create a better burn multiple is to improve your sales efficiency so you can increase your new ARR. This is where you have to get creative.
You don’t want to increase expenses too much, since that would increase your burn rate. Instead, you can find ways to lower your CAC (customer acquisition cost) through improved marketing efforts.
Another factor to consider is that the burn rate looks at actual cash on hand, while ARR looks at revenue, which is paid out as cash over a long period of time. It is critical, therefore, to ensure that you are creating an accurate cash forecast from your ARR figures to ensure that you will indeed have the cash you need to burn, when you need it.
The Hype Factor
The Hype Factor is a measure of how much a startup is “hyped” and how much of it is actually a viable business in the real world. It measures capital raised against net new ARR.
Basically, if an entrepreneur is the best salesman in the world, she can sell her idea and raise a lot of capital for the business, but the real test comes when the product or service is actually on the market. Can it actually create revenue (new ARR)?
If a startup has a high “hype factor” it has a lot of capital raised, but very little in actual revenue. A low “hype factor” means that the startup has low capital raised, and is efficiently converting that capital into sales and subscriptions.
The burn multiple is essentially a way of taking the hype factor beyond the startup phase of an SaaS company and giving it a life once the company is creating its own cash to burn.
FAQ: What is the difference between burn rate and burn multiple?
The burn rate is the rate at which the company is going through its existing cash reserves. If a company has $50,000 per month in net cash losses, its burn rate is $50,000.
The burn multiple, at its simplest, compares the burn rate to new ARR acquired during the period. This shows how efficiently the company can turn its expenses into new revenue.
FAQ: Can you have a negative burn multiple?
Yes, it is possible to have a negative burn multiple. If you have a negative burn rate, meaning that the company is bringing in more cash than it is spending, then the burn multiple will be negative. This is usually seen in well-established SaaS companies.
Check out my series on SaaS and growth metrics to go even deeper.