A Blog by Jonathan Low


Apr 30, 2015

When to Call a Market Top: YCombinator Founder Terms Startup Burn Rates 'Frightening'

Burn rate is the phrase used to describe the speed with which startups spend the money that investors have given them.

While most of those associated with Silicon Valley swear up and down that there is absolutely, definitely, in no way a bubble forming in the tech industry, they will also be quick to tell you that there has never been a better time to raise money.

This is because tech is the only thing the US makes anymore that is globally competitive, aside from movies and baroque financial maneuvers. 

Usually, when money is cheap and easy, so is the behavior associated with spending it. This is basic human nature, especially in tech where failure is celebrated as a valuable learning experience. This is particularly true of those whose failures come at the expense of other people's money. Which is to say, everyone in tech. Their contribution has generally been the value of their brilliance, most of which was paid for by their parents in the form of tuition and their former employers in the form of experience.

So when someone whose business is identifying, funding and nurturing startups says burn rates are getting scary, it may be time to consider investment opportunities in dry cleaning or pet care franchises.  JL

Alyson Shontell reports in Business Insider:

Investors are saying companies are raising too much money, but they say this while they’re out raising the biggest funds ever ... VCs talk about burning too much money, and these are the the VCs who are writing all these checks and letting startups burn all this money.
Sam Altman, the head of Silicon Valley startup accelerator program Y Combinator, doesn't think the tech industry is in a valuation bubble.
But he does think startups are burning "frightening" amounts of money every month.
Altman detailed his fears in an email he sent to Y Combinator alumni this past weekend, and in a phone conversation with Business Insider on Monday morning.
"I still feel, as I've said for the past couple of years, that valuations are high, but they seem reasonable for a zero interest-rate environment," Altman said. "But I think there are more companies burning $1 million a month than there were one year or two years ago."
High startup burn rates are one measure investors have used to determine whether or not tech-bubble talk is real. Fred Wilson, an early investor in Twitter and Foursquare, admitted that some startups in his portfolio burn a few million dollars a month. "It is more [companies] than I’d like, and more than I’m personally comfortable with," Wilson wrote in September.
Another investor, Marc Andreessen, also wrote in September that "many high burn rate companies will VAPORIZE" as soon as the market turns.
Altman says being aggressive with growth, and spending money to get results, is fine. But when money is spent inefficiently, it becomes a problem.
"It's OK if you want to spend money to be aggressive for growth or speed," Altman says. "The thing that is not OK is if the plans change or environment changes, you should be able to reach profitability on the money you have. What is OK is to spend money for productivity. What is not OK is just to light money on fire."
What does lighting money on fire look like?
There are two worrisome tactics Altman often sees in the startup world. Founders will hire large, expensive engineering teams then ship products slowly, or they'll spend too much money acquiring unvaluable customers.
E-commerce startup Fab is one example of startup that killed itself by blowing too much cash.
Investors once valued Fab at $900 million. But to reach Amazon-like scale, Fab's board decided the company should spend a ton of money every month, then raise $300 million a few months later. Fab spent a lot of money on marketing and customer acquisition, but those new users ended up not being very loyal, and they didn't have strong repeat buying patterns.
When it came time for Fab to raise the $300 million, investors didn't bite. Fab was only able to raise half the amount, and it led to a major pivot in the business model and severe layoffs. The remainder of Fab was acquired for about $30 million by PCH Innovations in February.
Altman believes Fab was an extreme case of burn rates gone bad. But he says it's never good to be at the mercy of investors.
"If you're a founder, you shouldn't want that," he says. "If a company is profitable, the founder is in control. If it's not, investors are in control."
One tip he often offers Y Combinator founders: Treat every round of financing like it's your last.
Some private companies, like Slack and Uber, have no problem raising capital. But those companies are outliers. Plus, raising a ton of money also doesn't ensure a startup's survival.
Bill Gurley, a Snapchat and Uber investor, told the audience at South by Southwest that he expects to see "many dead unicorn" startups this year.
Sequoia Capital's Mike Moritz, who invested in billion-dollar startups Instacart and Stripe, agrees. He recently told the Times of London, "A considerable number of unicorns will become extinct."Altman also believes a few unicorn startups (startups with $1 billion-plus valuations) will die. He says that's a natural part of the startup ecosystem. But he believes many will also live, and he's skeptical of some investors who are wailing about a bubble. Altman says:
The investors who complain about [high valuations] are the investors who invest in it. One thing that’s really broken is, all these investors are saying companies are raising too much money, but they say this while they’re out raising the biggest funds ever ... Any rational observer sees VCs talk about burning too much money, and these are the the VCs who are writing all these checks and letting startups burn all this money.
He adds, "The people calling the bubble are the people perpetuating the bubble. I've never seen anything like it."


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