In a perfect world, your SaaS start-up would be profitable from the get-go. But the reality is that most SaaS businesses lose money initially and intentionally to grow. They lose cash month after month, and it can be the smart approach if done for the right reasons.
What is Cash Burn?
As we explain here, there are two ways of looking at cash burn: gross and net. Gross cash burn is the amount of money leaving your company every month, ignoring what’s coming in. At Element, we prefer to look at net burn. Net cash burn shows you how much you lose after customer payments. For instance, if you have $200,000 coming in but spend $300,000, you’re burning $100,000/month.
Founders and their finance team must look at cash burn to assess their liquidity needs rather than accounting standards such as EBITDA. It’s all well and good to say you made money before interest and taxes, for example, but both represent cash going out the door.
When is it Ok to Burn Cash?
There are essentially two times when it’s ok to be burning cash on a net basis:
● When you’re developing your product: You won’t have any revenues at this point, so, naturally, you’ll be experiencing cash burn
● When you’re spending money to grow: If you’re burning, it should be to grow. If you’re burning and not growing, stop burning (and re-evaluate why the cash outlay isn’t translating into growth).
How Much Burn is Safe?
This is the big question. How much can you safely burn each month in search of growth? It depends very much on the available cash and if the burn is paying off in terms of growth or potential future earnings. As a general rule, we see net burn as a percentage of monthly recurring revenue of 50% or less. For example, your net burn will be 50% if you have $100,000 in revenue and are burning $50,000/month. (This means that your cash outlay is $150,000/month). In this example, if you have $1m in the bank account, you have 20 months of runway at the current burn rate.
Net burn that is significantly above 50% can be a warning sign. However, as we said, it depends on the following:
● Perhaps you have a ton of cash on your balance sheet. If so, you probably have a lot of cash runway (see our previous post) and can afford to keep burning cash.
● How much are you growing?
This second part is crucial. Say you have a high burn rate but an even higher growth rate. In this case, assuming sufficient cash runway, continuing to burn might be a good option. Another way of saying this is that if you have a reasonably low Customer Acquisition Cost, you’re efficient at spending money to earn money (burn to earn, as it were). Perhaps you spend a dollar to earn $4. Indeed, one of the great things about SaaS businesses is customer revenue's potential longevity and stickiness. You can spend money now to acquire a customer but easily have them stay with you for 4-5 years.
Of course, if you’re not spending money efficiently, a big cash burn is a problem. Maybe, rather than spending a dollar to earn $4, you’re doing the opposite: spending $4 to make a dollar. That’s where large, sustained cash burns are a big warning sign because they’re not translating into future growth. This won’t last long, as you will go out of business.
What We Like to See When it Comes to Cash Burn
At Element, we know SaaS businesses have to burn cash in the early stages. So if we’re thinking about whether to lend to one that is experiencing net burn, we like to see two things:
1. Managed burn: Rather than being out of control, we prefer to see reasonable levels of cash burn built around solid growth metrics
2. A solid cash runway: High levels of burn require big cash runways for a company to continue operating, so make sure you have thought about how you are going to get through the next two years to profitability
Cash is King
You may have a great product and a vast number of prospective customers. But remember that to be in business, you must stay in business, and that’s why keeping an eye on your cash burn is paramount.
Are you burning money to grow and looking for a bit more cash runway? At Element SaaS Finance, we lend to growth-focused SaaS businesses just like yours. We offer easy-to-understand term loans with no hidden conditions and don’t ask for board seats. Give us a shout anytime, and we’d be happy to chat.