When diving into the world of startups and young companies, investors often come across various metrics and terms to evaluate the financial health, growth prospects, and valuation of a business. One such metric that's been gaining attention is the "burn multiple". In this article, we'll take a deep dive into the burn multiple, understand its significance, and see how it can be used effectively by investors.
What is the Burn Multiple?
The burn multiple is a financial metric that measures the rate at which a company is burning cash relative to its revenue growth. Specifically, it's the ratio of net cash burn to net new recurring revenue.
The formula for the burn multiple is:
Burn Multiple = Net Cash Burn / Net New Recurring Revenue
Net Cash Burn is the amount of money a company is losing over a specific period (typically a month).
Net New Recurring Revenue is the increase in recurring revenue over that period, usually from subscriptions or other consistent income streams.
Why is Burn Multiple Important?
Efficiency of Growth: The burn multiple can indicate how efficiently a company is growing. A lower burn multiple suggests that a company is achieving growth at a relatively low cost, while a high burn multiple might indicate that a company is spending too much to achieve its growth.
Sustainability: For startups, especially those in the SaaS (Software as a Service) sector, growth is essential. However, growth at the cost of burning through too much cash too quickly can be detrimental in the long run. The burn multiple helps investors gauge the sustainability of a company's growth trajectory.
Valuation and Investment Decisions: The burn multiple can also play a role in valuation. Companies with a lower burn multiple might be deemed more attractive as they offer more bang for the buck in terms of growth per dollar spent.
Examples: To better understand the burn multiple, let's consider a few hypothetical examples.
Net Cash Burn: $100,000
Net New Recurring Revenue: $200,000
Burn Multiple = 100,000 / 200,000 = 0.5
Company A has a burn multiple of 0.5, which means it's burning 50 cents for every dollar of new recurring revenue. This is a fairly efficient growth rate.
Net Cash Burn: $300,000
Net New Recurring Revenue: $150,000
Burn Multiple = 300,000 / 150,000 = 2
Company B has a burn multiple of 2, indicating it's burning $2 for every dollar of new recurring revenue. This might raise concerns about the sustainability of its growth.
Caveats and Considerations:
While the burn multiple is a valuable metric, it's essential to view it in the context of other financial and operational metrics. Here are some things to consider:
Stage of the Company: Young startups might have a higher burn multiple as they invest heavily in growth. As they mature, the burn multiple should ideally decrease.
Industry Norms: What's considered a high or low burn multiple might differ from one industry to another.
Absolute Numbers: While the ratio provides insights, looking at the absolute numbers (like total cash reserves) is equally crucial. A company with vast cash reserves might sustain a higher burn multiple for a longer period than one with limited cash.
The burn multiple is a useful tool for investors to gauge the efficiency and sustainability of a company's growth. While it provides a snapshot of the company's financial health, it's essential to use it in conjunction with other metrics and qualitative factors to make informed investment decisions. As always, thorough due diligence is key to understanding the complete picture of any investment opportunity.