Published in the San Diego Union-Tribune, June 20, 2016
Burn, baby, burn. No, I am not talking about the riots in Watts in 1965. I am talking about how companies spend money – i.e. their burn rate, how fast they go through their cash.
When we use the phrase “a company’s burn rate,” we are talking about how much net cash a company spends per month to support its employees, rent, travel, etc. Gross revenue is all the money that comes in; net revenue is what is left after paying all the bills. Burn rate is how fast or slow the net revenue changes. In startup-ville, it measures the time between now and then – needing to raise more money, driving to positive cash flow or going broke. Simple stuff, or so it seems.
But Ron Berman, an assistant professor at Wharton, has done some interesting research. First, the obvious one. He says that if you spend too much, too fast, you will die. But it turns out that spending too little, too slowly also leads to the startup mortuary. It’s the “three little bears” syndrome – spending just right.
I see this frequently in my companies. I want the CEO to understand the amount of time it takes to raise money, to really viscerally understand that when you need money “to save the company” from imploding, it will be very expensive money. Also, it will always take six to nine months to raise venture money, not 45 days. I go ballistic when my CEOs do not worry – 24 hours a day – about when they will go broke.
Berman has another finding that is a whopper. It turns out that “adding a lot of experience to entre-preneurs doesn’t make the companies fail less.” Whoa! What about the “been there, done that” mantra? Everyone wants to back the CEO who is on his second or third company. But Berman claims that having been a CEO previously does not insulate you from current stupidity and running out of money – no better than the first-timer. I am suspicious of this finding, but it comes from the Kauffman Foundation that collected data from 3,000 companies. It’s hard to argue with big data, but I still prefer to write checks to someone who has had their brains beaten in once before. Makes them a bit more humble – I hope.
What I do see clearly is that how one makes decisions, i.e. how one thinks about the process of decision making – seems to strongly influence success. Not just the decision itself – but the “how” you got to it. How the CEO thinks about money influences burn rate. There is no data, but I wonder if the rich kid (or the company that has raised “too much money”) is less concerned with burn rate than the bootstrapper. I like to think grit triumphs.
I coach a young man (50, that is what I think of as young) who runs a big company, and our sessions are not only metric (how much revenue etc.) but also psychological, meaning I ask a lot of “what if” questions. We don’t just work on the answer, but the how we get to an answer. This is not easy for engineers, scientists and really smart people – because they know what they know, and they know it. So they are a bit impervious to “what if” questions. And one key area where I see weakness is finance.
Berman has a second bombshell. Education trumps experience. Another whoa! Dropping out of college actually works against startup success. (Tell that to Peter Thiel.) More education adds to the likelihood of success. Brains and rigor take precedence over gut.
Now, the last kicker is this one. “Spending too little increases the chances of failure of the company.” I really get this one. On several occasions, I have had to prod my CEOs to go “all in” – go to the conference, hire the person you really need, spend on the website, etc. It is the “crossing the chasm” syndrome.
If you are Evel Knievel, there are only two outcomes – you land on the other side or you land at the bottom of the canyon. It’s the same with companies. There is always a point of no return, when you have to gun it – speed and trajectory coupled with prayer. Failure to spend at that moment comes with huge lost opportunity cost.
Knowing when and where that point is – that is the magic of leadership.
Rule No. 470
When it’s gone, it’s gone.