What are the most typical mistakes that startups make that lead to higher cash burn rates?
The runway available to meet investor expectations, launch a funding round, or create a sustainable business is determined by a startup’s burn rate, which is its monthly operating expenses. Effectively controlling this rate is essential for long-term survival because excessive expenditure can quickly exhaust resources and impede growth.
This is the opinion of Aysha Saifi, a specialist in intellectual property (IP), valuation techniques, and cap table management.
Nevertheless, a lot of startups make the same mistakes, which result in higher-than-necessary burn rates and frequently jeopardize their financial viability. These errors, which range from overpaying staff to using subpar pricing techniques, result in increased costs without commensurate returns. We’ll assist you avoid these typical blunders in this post.
7 common mistakes that lead to high cash burn rates
Founders must closely monitor a startup’s burn rate to maintain financial viability because it dictates its runway. To properly regulate your cash burn rate, you must steer clear of these seven blunders:
Bad choices on hiring and pay
Employee remuneration accounts for a significant amount of the monthly operational expenses at the majority of companies. Therefore, a startup’s survival depends on its employment decisions. According to sources, between 70 and 80 percent of a startup’s operating costs go into payroll. When a startup approaches a significant milestone, this trend becomes more pronounced. For example, a startup’s payroll costs will account for 140% of its revenue four years before it is listed.
Founders must strike a balance between the necessity of having a significant runway and the importance of creating a dynamic and resilient staff. Deferring a portion of payroll costs in the form of stock-based compensation is one method to address this problem. Even so, you should make sure that your compensation packages are reasonable in relation to market-competitive wages and living expenses at the workplace, even if you are employing stock-based compensation to reduce your cash outflow.
Draining resources on non-core and unvalidated features
The Pixy drone camera was introduced by Snapchat in 2022, but the business canceled it four months later due to poor financial results. To make matters worse, the corporation was forced to recall and return every unit of this product in 2024 due to a fire hazard.
While a business the scale of Snapchat can withstand unsuccessful attempts to develop experimental items, startups may find that their burn rates are excessively increased in the early stages of such endeavors.
Therefore, when experimenting with new features and products, founders need to exercise considerable prudence. A startup should ideally introduce new features in a small market, get feedback, identify any problems, and fix them before distributing them to its user base.
Ineffective advertising campaigns
According to marketing experts, companies should allocate between 10% and 20% of their sales to marketing. Founders must, however, decide when marketing should take center stage in their plan. A startup doesn’t have to spend a lot of money on marketing right away just because it has a minimal viable product (MVP).
At this point, getting feedback and making the product better must be the main priorities. Startups must postpone marketing expenditures until a reasonable degree of product-market fit is attained. In addition to expediting product development, this strategy guarantees that marketing efforts generate significant momentum upon launch.
Non-core assets being overloaded
A startup should aim to be as asset-light as possible, particularly in the early stages, in order to increase its runway. Renting an office rather than purchasing one is the ideal course of action because it protects the company from changes in interest rates and gives them the freedom to downsize if necessary. In a similar vein, renting commercial cars is better than purchasing them, but collaborating with logistics companies when necessary is an even more astute strategy.
Relying on contract manufacturers is far more cost-effective than setting up manufacturing lines that require frequent overhauls if your firm hasn’t yet decided on the best product configuration. This strategy would entail depending on server subscriptions and other digital solutions rather than making significant investments in IT infrastructure for SaaS firms.
Poor pricing strategy
If a firm gets product-market fit but has trouble gaining traction or doesn’t successfully monetize, it can be mispricing its products. SaaS firms that are known to provide both freemium and premium versions frequently have such inefficient pricing.
The main advantages of this pricing strategy, as seen from the perspective of the SaaS firm, are that it makes customers more accustomed to the software, encourages a certain amount of lock-in effect, and encourages them to purchase the premium version. The transition from freemium to premium would stall, though, if customers find the freemium version to be sufficiently useful and the premium features are superfluous extras for the intended market.
A situation where the firm develops a solid product, acquires traction, and finds product-market fit but is unable to produce significant revenue can result from such pricing errors, which will ultimately cause a high net burn rate.
Growth motivated by incentives
When used properly, incentive-driven growth can draw in a sizable percentage of the target market as new customers, tie them down to a premium price, generate early traction, and set the stage for future income production. Nevertheless, a startup’s long-term goal shouldn’t be incentive-driven growth.
Cashback, commissions, referral bonuses, and other incentive-driven tactics should ideally be used sparingly by businesses in order to generate initial momentum that may subsequently be capitalized with standard pricing models.
However, entrepreneurs frequently use incentive-driven growth to inflate user figures.
Customers grow accustomed to the reduced pricing, and these startups suffer from high customer acquisition costs (CAC). Therefore, such firms would lose throngs of customers without recouping their investment in incentive-driven growth campaigns if incentive-driven growth became commercially unviable.
Scaling too soon
Increasing marketing and payroll expenditures, acquiring important assets, and introducing new features, product lines, or product launches in new markets are all part of scaling operations. This is a business choice that has the potential to dramatically raise your gross burn rate over night, and it can only be justified if it results in a notable boost in sales.
In certain instances, a firm may not scale too soon, but it may pivot too soon, putting profits ahead of creating a competitive product. These actions are especially harmful if reducing R&D costs does not result in improved cash flow because the startup will not be compensated for the higher risk of being overtaken by rivals. Although this tactic might reduce the rate of burn, it eventually raises the chance of failure.
Empowering startups to create lasting value!
The foundation of any strategy to reduce cash burn rates is sound financial planning, which includes precise financial forecasts and cautious cash flow management. When founders can quickly distinguish between important and non-essential projects and have a keen sense of when to launch new projects and make strategic changes, burn rate reduction tactics are significantly more successful.
