When investors drop hundreds of thousands, or even millions, of dollars into a startup, how can they be sure all that money will come back—and with high returns? A venture capitalist is the epitome of a risk-taker. But they aren’t foolhardy. They always perform “due diligence” to make sure that their risks are mitigated and that there are no obvious problems to undermine their investments.
Feelin’ the Burn
That’s why, when an early-stage startup makes a pitch to the Sharks, they’ll inevitably be asked about their “burn rate.” Early-stage startups are often “pre-revenue.” Their product may consist of a mere idea, or perhaps a prototype. They need investment to begin manufacturing. But in the meantime, the company is spending money and incurring expenses. Seed capital has to cover the basic overhead of the company as well as the costs of production.
And so VCs want to know how much money the startup is spending each month, as they work toward production, sales, and eventual profitability. Likewise, they want to know how expenses are projected to increase on the way toward profitability—since the infrastructure of the company will have to scale to keep up with the growth.
It can sometimes take years for a startup to move from early-stage, where they have no revenue at all, to growth-stage, where money is coming in but the cost of growth and scaling consume revenue to the point when they finally break even and eventually see profits.
Projecting Your Burn Rate
Therefore, as part of due diligence, investors ask for detailed “pro formas,” essentially a spreadsheet that estimates expenses over time, layered with revenue projections, ultimately forecasting the point in time at which they will become self-sustaining and profitable.
When an investor asks about “burn rate” they’re trying to get a feel for how quickly their investment is going to be used up, and to know how much more money the company is likely to need in order to reach profitability. A related question you may hear them ask pertains to the startup’s “runway.” How much cash do they have currently, and based on their burn rate, how long will it last until they need more?
These are critically important questions that any investor will demand answers to before they risk their capital.
What is Your Creative Practice’s Burn Rate?
But what about your practice? What’s the “burn rate” for your business? And how much runway do you have right now before you’re going to need more revenue? Do you have a “pro forma” that projects your expenses and your revenue for the next several months?
VCs don’t part with their money easily, and you shouldn’t expose your own investments of time, energy, and money without evaluating these important metrics. Especially since, unlike a typical startup, you really have to be operating profitably from day one, there are no investors that will infuse capital into your business to cover shortfalls.
Pro Formas that Don’t Perform
Occasionally a VC, in evaluating a prospect, will conclude that the company’s prospects aren’t very good. Their burn rate is too high, their runway inadequate, and their pro forma forecasts profitability so far out into the future that they doubt the company will make it that far.
For creative entrepreneurs, if you put together a pro forma for your practice, you might discover that your burn rate is higher than your revenue projection. Because the effects of low, or even negative margins on your work are experienced later in a project cycle, rather than in the form of upfront costs, creatives often delude themselves about their performance. Additionally, since your own time is the prime cost center, your expenses become fluid. Without a pro forma, you can go for long stretches of time obscuring the true situation.
How to Build a Pro Forma for Your Creative Practice
If you’d like to build a Pro Forma for your creative practice you can do that in the form of a cash flow projection spreadsheet. By maintaining this document you will be continually aware of how your revenue and expenses are impacting your burn rate.
Here are a few resources to help you project your performance.
Google Spreadsheet Template. Use this link to download a model spreadsheet designed for creative services to track their expenses and revenue over time.
There is a bit of a learning curve in gaining these skills, and to practically manage this spreadsheet. The following videos will introduce you to the practice and walk you through the process of tracking your cash flow so that you never get burned, or run out of runway.