A startup’s burn rate, defined as its monthly operating expense, determines the runway available to meet investor expectations and open a funding round or establish a sustainable business. Managing this rate effectively is crucial for long-term survival, as overspending can quickly deplete resources and compromise growth.
This according to Aysha Saifi, who specialises in cap table management, valuation strategies, and intellectual property (IP) topics.
However, many startups fall into common traps that lead to higher-than-necessary burn rates, often undermining their financial stability. From overcompensating employees to poor pricing strategies, these mistakes lead to rising expenses without corresponding returns. In this article, we will help you sidestep these common mistakes.
7 common mistakes that lead to high cash burn rates
Since a startup’s burn rate determines its runway, founders must keep a close eye on it to ensure financial sustainability. Here are seven mistakes you must avoid to manage your cash burn rate effectively:
- Poor hiring and compensation decisions
At most startups, a large portion of the monthly operating expenses is made up of employee compensation. Hence, making the right hiring decisions is crucial to a startup’s survival. Sources report that payroll expenses account for 70 per cent to 80 per cent of a startup’s operating expenses. This trend gets magnified when a startup is nearing an important milestone. For instance, four years prior to a startup’s listing, its payroll expenses will reach 140 per cent of its revenue.
While building a dynamic and resilient team is essential, founders must balance it with the need to have a sufficient runway. One way to resolve this issue would be to defer a part of the payroll expenses in the form of stock-based compensation. However, even when you are using stock-based compensation to limit your cash outflow, you should ensure that the compensation packages you offer are not extravagant when compared to market-competitive salaries and living costs at the job location.
- Draining resources on non-core and unvalidated features
In 2022, Snapchat launched a drone camera called Pixy, however, the company discontinued this product within four months of launch after an underwhelming earnings result. To add insult to injury, in 2024, the company had to recall and refund all units of this product as it posed a fire hazard.
While a company of Snapchat’s size can survive fruitless forays into experimental products, at earlier stages, startups may end up over-aggravating their burn rates with such pursuits.
Hence, founders must demonstrate extreme caution when experimenting with new features and products. Ideally, a startup should launch new features in a small market, collect feedback, understand the drawbacks, resolve issues if any, and only then launch said features across its user base.
- Inefficient marketing campaigns
Marketing experts suggest that startups should spend about 10 per cent to 20 per cent of their revenue on marketing. However, founders must determine when marketing should become a core part of their strategy. Having a minimum viable product (MVP) doesn’t mean a startup should immediately invest heavily in marketing.
At this stage, the focus must be on gathering feedback and improving the product. Until a satisfactory level of product-market fit is achieved, startups must hold off on marketing expenses. This approach not only accelerates product development but also ensures that when marketing campaigns launch, they create meaningful momentum.
- Overloading non-core assets
To extend its runway, a startup should try to be as asset-light as possible, especially in the early stages. The best starting point is renting an office instead of buying one, as it shields the startup from interest rate fluctuations and offers flexibility to downsize if needed. Similarly, leasing commercial vehicles is preferable to buying them, but an even smarter approach is partnering with logistics providers as needed.
If your startup is yet to zero in on the ideal product configuration, it is much more cost-effective to rely on contract manufacturers than to set up production lines that need to be overhauled frequently. In the context of SaaS startups, this approach would translate to relying on server subscriptions and other digital solutions instead of investing heavily in IT infrastructure.
- Poor pricing strategy
A startup may be mispricing its products if it achieves product-market fit but struggles to gain traction or fails to monetize effectively. Such suboptimal pricing is often found in SaaS startups that are known to offer freemium and premium versions.
From the SaaS startup’s point-of-view, the major benefits of this pricing model are that it familiarizes the users with the product, fosters a certain level of lock-in effect, and pushes the consumer towards the premium version. However, if the freemium version offers enough utility to the users and the premium features are unnecessary luxuries for the target audience, the migration from freemium to premium would stagnate.
Such pricing missteps can lead to a scenario where the startup builds a strong product, gains traction, achieves product-market fit, and yet, fails to generate meaningful revenue, ultimately leading to a high net burn rate.
- Incentive-driven growth
When applied correctly, incentive-driven growth can attract a significant portion of the target audience as first-time users, anchor them to a high price point, drive initial traction, and lay the foundation for future revenue generation. That being said, incentive-driven growth should not be a startup’s long-term strategy.
Ideally, startups should use cashback, referral bonuses, commissions, and other incentive-driven strategies sparingly, primarily to build initial momentum which can later be capitalized with regular pricing models.
However, startups are often guilty of inflating usage statistics through incentive-driven growth.
As a result, such startups suffer from high customer acquisition costs (CAC), and the customers get used to the discounted prices. So, when incentive-driven growth becomes financially unviable, such startups would lose hordes of customers without recovering their investments into incentive-driven growth campaigns.
- Premature scaling
Scaling operations involves increased expenditure on marketing and payroll, acquisition of key assets, and launch of new features or product lines or launch of products into new locations. This is a business decision that can skyrocket your gross burn rate overnight which can only be justified if it leads to a significant increase in sales.
In some cases, a startup may not scale prematurely but pivot prematurely, shifting focus from developing a competitive product to prioritizing profits. These moves are particularly detrimental if cutting R&D expenses doesn’t lead to positive cash flow as the startup will not be receiving any pay-off for the increased risk of being overshadowed by competitors. While this strategy may slow the burn rate, it ultimately increases the risk of failure in the long run.
Empowering startups to create lasting value!
Effective financial planning comprising accurate financial forecasts and careful cash flow management forms the core of any strategy to mitigate cash burn rates. Burn rate reduction strategies are even more effective when founders can easily differentiate between essential and non-essential initiatives and have a strong sense of timing for launching new initiatives and executing strategic pivots.
