Cash is an essential part of any startup operation, and without it a business can’t continue to run. According to CB Insights, 38% of startups cite lack of capital as one of the top reasons they fail. So naturally, many investors want to understand how much money a startup uses for its day-to-day operations to better understand if the company will be able to sustain itself. And they want to understand how quickly that money is used. The combination of how much money a startup uses and how quickly it is used results in a metric called its burn rate. By taking all the money a startup used over an entire year and dividing that amount by 12, we can estimate a company’s monthly burn rate. For example, if a company spent $1 million on operations during a fiscal year, its monthly burn rate would be just over $83,000.
Burn rate can be helpful in estimating when a company might completely run out of cash. If the amount of cash a company had for a specific year was $2 million and it had a burn rate of $83,000, it could continue to run for 24 months without any extra funding or revenue (this is referred to as its runway). However, burn rate is also especially crucial for evaluating early stage startups as they might not have cash flow, paying customers, or even a minimum viable product yet. Understanding how quickly these young startups are going through cash can help investors assess how efficiently the business is being run.
But there’s one big caveat here — industry. Burn rates can differ drastically from one industry to another since each industry comes with its own unique set of conditions and business models. In this Chart of the Week, we examined the average monthly burn rate across more than 20 unique industries to identify which have the highest and lowest burn rates in the online private market.
All early stage Regulation Crowdfunding and Regulation A raises that opened between Jan 1, 2020 and Sept 15, 2022.
I was pretty surprised by the fact that startups in the real estate and construction industry had the lowest monthly burn rate. I expected a more software-focused industry to come in at the bottom. But I think there are a few reasons for real estate and construction startups to be so capital un-intensive. Many of these companies are still in their very early stages — more than half (52%) of these startups have a burn rate of $0 because they are still in the ideation phase. These startups haven’t spent any cash yet, which leads to a lower average burn rate when compared to other industries. And there are startups in this industry that are developing software solutions as well. The same is true for apparel and fashion, the industry that came in second lowest. It’s also important to note that there haven’t been many early stage apparel and fashion startups raising capital online, so our data set for determining average monthly burn rate in that industry is limited. The business services, software, and applications industry came in third lowest for monthly burn rate. This result makes sense since most software or service application companies don’t need to spend capital on manufacturing and selling physical products. And that makes it easier for them to have high capital efficiency — especially when they are still young.
The industry with the highest monthly burn rate was transportation, automotive, aviation and aerospace. Startups in this industry spend a lot on research and development, patenting their technology, and producing hardware. It also requires more manual labor, which is very different from software companies that may only need a few developers to create a product. All of these factors lead to high burn rates.
The security, cybersecurity, and defense industry came in second highest. Although more than half of the cybersecurity startups in this data set are software-focused, this sector still spends a lot on research and development. Furthermore, many of these companies target government and military agencies or other businesses as customers. Business-to-business sales tend to take a long time to complete (often referred to as a long sales cycle). A combination of long-term product development and long sales cycles can easily lead to high burn rates for young startups that have not yet secured customers.
Finishing out the top three for monthly burn rate was farming and agriculture. Many of these startups are robotics companies which work toward automating farming and cultivation. So it is not a surprise these companies have to spend a lot of capital on their hardware and technology.
Knowing the industries with the highest and lowest monthly burn rate can be useful for investors when evaluating startup investment opportunities. The more efficient a company is with its spending, the more likely it is for that company to scale operations and meet increasing demand. Additionally, a high burn rate could mean it takes longer for investors to see a meaningful return. But it is important to keep in mind that a high burn rate is not automatically bad. A young company that’s spending aggressively on product development and customer acquisition would likely have a high burn rate. But all that spending could easily pay off if it nails its product-market fit and marketing strategy. And lastly, monthly burn rate isn’t a static characteristic. For example, late stage real estate and construction startups have a 663% higher monthly burn rate than their early stage counterparts. So while monthly burn rate is a useful metric, it’s important to consider it in tandem with a startup’s financials, industry, and development stage.
Note: All data on online startup investing used for the Chart of the Week comes from the KingsCrowd database and represents a snapshot of the US crowdfunding market.
