Help! I’m filling out an application to present at an angel investment group. It’s confusing. What does monthly burn rate mean? Also, what is a pre-money valuation? How important are these numbers?
It seems every industry has its share of jargon. At Start on Purpose you can learn the fine points of how VCs and angels challenge A-players to drill down to the secret sauce before issuing an LOI.
This means potential investors aggressively quiz well-respected entrepreneurs to talk about the competitive advantages of their business ideas before issuing a written proposal of deal terms. Whew!
A company’s burn rate is, quite simply, the speed in which a company is “burning through cash.” You may also hear investors call this number the “monthly nut.” The total amount that you are spending each month, usually before revenue generation from customers, is your company’s burn rate.
Smart seed-stage and early-stage investors know that one of the biggest risks to their investment, is a company running out of cash before reaching cash flow breakeven (the point in which cash payments from customers exceed monthly expenditures).
Another way founders and investors lose is when a business that faces a long period of expensive product development is not able to raise funds successfully in subsequent investment rounds. In this situation, the company will either close or be forced to raise funds at a lower share price than prior investment rounds. This is called a “down round.”
It’s important to note that angel investors may ask about your current burn rate and projected burn rate. After all, with new money in hand you may hire more staff or lease office space increasing your monthly expenses.
Now to pre-money valuation. While most entrepreneurs believe their business ideas are worth gazillions, your pre-money valuation is what you say is your company’s worth today. A post-money valuation is the total of your pre-money valuation and the amount of new investor funding.
Because your company doesn’t yet have revenues or earnings, you will have to rely on qualitative company attributes to reach your pre-money valuation estimate.
These favorable attributes can include expected high profit margins, patent filings, large target market, customer loyalty to your product or service, the ability of your company to be a market leader and the potential to be acquired by a larger company at an attractive price.
Here's one last comment: Investors prefer to invest in companies where the deal pricing leaves room for significant upside, plus compensates them for the high risk associated with investing in pre-revenue companies. They like to buy-in low in order to sell high.
When entrepreneurs set high pre-money valuations they set themselves up for fast turn downs. These entrepreneurs are called “unrealistic,” “clueless” or “financially sophisticated” in terms of the current market rate for startup capital. There are many angel investment groups that discourage entrepreneurs from applying if they set pre-money valuations greater than $2 or $3 million.
For extra insight, expand your ecosystem to include the CEOs of companies that have previously raised money from your local angel organization. Many angel club websites will list recent investments in local companies. Learn as much as you can about their fundraising experiences. You can do it!