Budget & Burn

At the early stages a critical factor that determines your Startups success or failure, is the level of spending or burn rates. Practicing extreme financial discipline is a crucial part of controlling your companies burn rate. Tune in to this episode of #MatrixMoments, where Avnish Bajaj, Founder & MD, Matrix Partners india, talks about the importance of business performances, plans, burn rates and budgets.

Salonie: Hi and welcome back to Matrix Moments. This is Salonie. And today’s episode is about business performances, plans, burn rates, and budgets, why does all of this matter. Joining us to discuss this is Avnish Bajaj, Founder & Managing Director, Matrix Partners india.

So, Avnish, what is the relevance of plans to VC investing and Startups?

Avnish: Thank you for having me back, Salonie. And happy to be back for another Matrix Moment. So, look, in VC investing, we are essentially trying to underwrite the future. it’s one of the most futuristic businesses and also what we all enjoy the most. And i would say inherently there is ambiguity by definition because it’s very hard to know the future and especially if you are trying to do very disruptive things.

So in my view, a plan is a convergence between what the founder you are backing because it’s really their view of the future that you are buying into, and your view of it, and how do you converge these things. Because somebody comes and says, they are going to do something big, how do you know whether that is going to work or not? And how do you get on the same page so to speak? And that to me is a plan.

Tactically, the way it actually works is that as a Venture Capitallist, you would have some form of an investment memo. And in that investment memo, you essentially are going to be putting down a plan of what success would look like. And therefore, it provides the markers towards that success.

Salonie: Okay. But why does it matter given the early stage businesses are by definition hard to predict?

Avnish: See, in my view when a founder and an investor are getting into a relationship, they are in some ways signing multiple contracts without signing them. One contract they are signing is a legal contract. That’s the most obvious. That’s the one - in my view that’s probably used the least.

The other contract, which i think both are signing up for, is a moral contract. And you know with our philosophy of founder’s first that’s something we probably A) Put the most emphasis on, and B) Spend the most time on figuring out if this is something that works for both sides. And that moral contract is more around what people expect from each other. And frankly, it is at least in the investments i lead or as Matrix when the investments we lead, we do spend time talking about those expectations.

The third contract that you are actually signing up for is the plan, the performance contract. And often that may not be something that people will spend a lot of time on specially if it’s a very early stage business, but you should. Even if it’s early stage, one needs to have like i said a common language or be on the same page of saying, this is what success would look like. if we are not tracking to this, then maybe we need to think about things differently. So i think this provides a common frame of reference. And to me a plan is essentially a business contract that both sides are signing up for.

Salonie: Okay. But having been on both sides that as a founder and now investor, how do you feel about the need to have discipline around plans and burn rates? And are there any learnings on this front?

Avnish: So i was clearly a founder at the time of Baazee and we actually didn’t have much of a market. And really all we could do was manage the cost for a period of time until we were able to get some version of product market fit. And therefore, we managed to have a business that over a period of time became more sustainable. i don’t think people in india in the ecosystem be it the investors or the founders, i think we are in a very early stages of thinking through burn rates carefully.

See, in a business especially at the early stage, the things you control are more on the cost side than on the revenue side. On the revenue side, there are bunch of punts involved. Whether this product will find the right market, the right users. Whether it will start growing on its own without marketing too much. Whether you will be able to monetize from the users. You are taking all these punts, right?

On cost side, you are taking no punts. You are renting an office, you have to pay that. it’s not like your landlord is going to wait and say, let’s see if your product market fit happens and then you pay me the rent. Same for the employees and so and so forth. So, i think it is extremely critical because costs are certain and revenues are not.

So one of the - as i have thought through it, one of the principles that i have started applying, and i think people should think about, is often people will guide the founders to say raise money for 18 to 24 months. Now, that’s a good principle. But, i think a better principle is to say raise money for 18 to 24 months. if things are going well, you can actually raise more money in 9 to 12 months because you have hit some kind of traction. if things are not going well, you should be thinking about 36 to 48 months, three to four years. Buy more time, control your destiny.

How do you control your destiny? if the input money is fixed, the only way you control your destiny is with burn rates. And in my view, putting a plan in place and being very disciplined on that plan on the burn rate because i know having been an entrepreneur myself i am investing in some many businesses, i know that beyond a point you cannot control product market fit. But, you need to buy enough time to get there. And you have to be able to control your own destiny. So, what i advocate is some rules of thumb.

Typically, if you are early you are probably raising maybe $1.5 million at a seed stage. i tell the founders keep very clear markers for a 30-lakh a month burn rate. A 50-lakh a month burn rate. A 70-lakh a month burn rate. And don’t go above that. Don’t spend on marketing until you have product market fit. Marketing is not the way to get product market fit. Marketing is the way to explore product market fit once you have it. if you were to do this kind of a math, by definition you would have money for 18 to 24 months with the amount that you have raised.

Now, let say that the business has starting to track. Then the second thumb rule or metric i give them is to say, now, start thinking of your revenue greater than your burn rate, which means you are burning 1 crore a month, how far are you from having a revenue of 1 crore a month? And typically, this is the first marker. And this is net revenue, not GMV or any of other vanity metrics. That is generally if you look at the financial architecture and financial health of a business, one of the early markers of progress in financial health.

Then, the next level i would say now start looking at your unit economics. Your gross margin, does it pay for your marketing cost? And by the way, this is a little bit of a philosophy i picked up. Normally people from one of the better later stage investors normally people say is your gross margin going to cover your fix cost? Because then i can pay for marketing. But actually if you are in a high-growth environment, you will always need to market. Or, you should be unless you have a business that’s just growing like weeds organically.

So gross margin covering marketing means you are able to pay for your growth. if you are able to pay for your growth, some period of time with more growth, your fix cost will get covered and you will become profitable. So that’s the other kind of thumb rule on how one should progress. But, i think overarching, which is what i had said earlier, keep control of your destiny. These are all markers.

The reason a plan is very disciplined exercise is to watch it month by month and say, how far am i getting away from this target of 18 to 24 months? And if my burn is too high, you need to figure out how to extend the runway. So in most of our early stage companies, the first slide will talk about burn and runway. And runways in number of months.

And i ideally i counsel founders if you are able to keep a perpetual 18 to 24 months runway, at some point you are going to become profitable. if you business is not tracking and it’s normal, just take the time to hunker down, fix the basics, and then get back on the trajectory of the burn rate that we spoke about.

And believe me in our portfolio there are a number of examples where the founder took the call to hunker down. Typically if businesses are not tracking quickly out of the gate, takes them maybe a year-and-a-half to two years of hunker down period before they get back on track. And it’s normal. And that’s not something to be worried about. What is to be worried about not doing that and kind of running out of gas before you have hit the markers of success. So, i think that’s the other key view in my view on controlling burn rates.

Finally, one thing i can share for you looking at our portfolio and again giving the importance of performance versus plan, all our best companies, the best returns have been companies that have hit or beat plans from day one. i mean it’s amazing. And the year after year, they have been hitting or beating plans. Now that’s kind of obvious. What’s not so obvious is that let’s say this is the top 5 - 10% of the companies. if you look at the next 20 - 30% where companies have done really well, over a 18-month to 2-year period or maybe 18-month to a 2.5-year period, they have started hitting plans.

And to me, my biggest takeaway is it tells me a lot about founders. See, if we are in the business of backing people future backwards, futuristic perspective, how good they are in predicting the future and managing towards it, is what a plan tells me. So if i had to say, what is my one-line summary of why performance versus plan matters, it is a measure of how good is the founder in understanding their market, in understanding the competition, in understanding the execution, and being able to predict the future and look backwards to, and that’s the one-line takeaway. And that’s where it matters.

Salonie: Right. Thanks, Avnish. Thank you for listening. And you can find the transcribed version of this podcast on matrixpartners.in. You can also follow us on Twitter and Linkedin for more updates.