Burn Rates: Tech Has a Burning Problem. But Is It Unsolvable?

High burn rates are the reason why startups go under. Everyone’s advocating cost-cutting, but no one can identify the deeper malaise in tech’s Spend Culture.

“We spent $200M in the past 2 years. $200M!…We spent 2/3 of the cash…
Holy shit this is a big deal.”
— Jason Goldberg, Former CEO of Fab, in a memo to his staff.

Outbursts, by their very nature, tend to be surprising. But what transpired inside the zany conference room of one of New York’s most urbane startups was surprising not only because of the staggering sum of money that forced the CEO to call the meeting.

What was truly surprising was that the way in which the company registered the scale of its spend was all too human — its reaction seemed not all that different from the archetype of some fiscally irresponsible millennial unable to anticipate that his credit card would max out so quickly.

Surely, companies (particularly startups, with their easy access to all manner of software, resources, not to mention the gaggle of VCs critically eyeing their numbers) would, at the very least, know how much money they are spending. They wouldn’t, one would think, end up spending more than the total GDP of the Marshall Islands and only learn about it later.

And yet, on that Friday morning of October 2013, as Jason Goldberg, the former CEO of Fab, faced a motley of his aides and executives, it did not look like the company had knowingly spent $200 Million, or that the massive outlay had been diligently accounted for in their budgeting.

Jason Goldberg is the former CEO of Fab, which was sold to an Irish manufacturing company for $15 Million.

Predictably, what followed this rude awakening was a severe retrenchment plan; two-thirds of the staff was to be laid off, and other major cuts were also in order.

Fab, once valued at $1 Billion, was poised to be an eCommerce behemoth and its investors’ crown jewel. Less than two years after that fateful meeting in Fab’s conference room, the company was sold to an Irish manufacturing company reportedly for $15 Million.

Despite cautionary tales like Fab, when it comes to burn rates, tech’s track record is disturbing. That startups burn through piles of greenbacks before turning profitable is by no means a revelation and is, as such, accepted as a quirk of #StartupLife. What should, however, give both entrepreneurs and investors a pause is that high burn rates are also the reason startups go under. In its Startup Failures Post-Mortems, CB Insights, a venture capital database, runs a real-time tally of startups that have floundered since 2014. According to CB Insights, the second most common reason behind startup failures, after the lack of the much vaunted product-market fit, is overspending and/or lack of control over spending.

And yet this wasn’t the only time the subject of burn rates became a talking point; only three years ago, ballooning burn rates across the tech landscape galvanized some of the most influential VCs to come out and voice their anxieties about tech’s burning problem.

“We’ve become comfortable with burn rates.”

— Bill Gurley

Bill Gurley is a partner in VC firm Benchmark. He is an Investor in Uber, Zillow, OpenTable.

It was Bill Gurley who opened the can of worms. Talking to the Wall Street Journal, he had explained that the easy availability of venture capital in the Valley had led to  unprecedented burn rates across companies. Joining the chorus was Fred Wilson of Union Square Ventures, who opined that burn rates were sky high all over the US startup sector and that multiple companies in his own portfolio were burning millions of dollars every month.

The Valley (synonymous, really, with US tech in general) is an echo chamber, and, soon enough, every VC with a public profile weighed in on the issue.

But perhaps the most searing indictment of the state of tech spending came from Marc Andreessen of Andreessen Horowitz.

Marc Andreessen
Marc Andreessen is the co-founder and general partner of Silicon Valley venture capital firm Andreessen Horowitz

We’ll save you our analysis of his tweet-explainer because its stridence says it all:

Andreesen’s torrent of tweets encapsulated not just investors’ growing anxieties about the abysmal state of tech’s Spend Culture, it also gave the impression — just like Gurley’s and Wilson’s strong-worded statements did — that VCs themselves were clueless about how the problem was going to be solved.

Here, it’s important to keep in mind that these are some of the most perceptive and shrewd investors in tech, and yet the solutions they offered were little more than paternalistic cliches about the virtues of thriftiness.

That there was an elephant in the room was manifestly clear; that there was now a growing impatience to address it was also clear. Exactly how the elephant was to be addressed, however, was anybody’s guess.

In arresting the Valley’s attention over how the culture of wasteful spending had metastasized across the industry, the VCs played an instrumental role in, to some extent, shifting the general discourse from hackneyed cliches about “Startup bubble” to “Burn rates”.

Perhaps catalyzed by this shift, a marketing professor from Wharton and an economist from NYU Abu Dhabi published Startup Survival and Balanced ‘Burn Rates’, a research paper that drew a strong correlation between a startup’s ability to control its burn rate and the educational qualifications of its founders. The more educated the founder, the paper concluded, the more likely it was that their startup would be able to keep its burn in check, and would, consequently, have a higher rate of survival.

Notably, the research did not find sufficient evidence to link longevity of work experience to chances of survival — which, it can be argued, is indicative of the fact that even founders with multiple startup experiences under their belt were clueless about what was the best way to control burn. And so, whilst the paper did not offer any remedial suggestions on how startups could take control of their spending (any suggestions to hire well educated founders with multiple university degrees wouldn’t hold water in an industry that holds college dropouts, self-motivated brainiacs and autodidacts in high regard), it did manage to prove that doing the same thing over and over again and expecting a different result is ultimately unlikely to produce one.

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Tech’s Myopic Memory

We are in the middle of 2017— it’s been over two years since Fab’s catastrophic collapse. One would think that the undoing of the budding giant of eCommerce would still be fresh in the tech zeitgeist, and would present a sobering lesson to even the most promising startups.  One would think that.

But, the tech industry has a myopic memory; not to mention, its tendency to be engulfed in waves of mass hysteria every time any startup archives unicorn status makes it so easy to lampoon that HBO has made a fortune out of it.

On May 2 this year, fittingly — you can say — a day after the International Workers Day,  Etsy, a company not all that dissimilar to the erstwhile Fab, announced that it would be laying off 8% of its workforce. The layoffs were the least of the company’s problems; what preceded the announcement, however, were a series of triggers that rattled the company only a few hours before.

By the time the layoffs were announced, the online market place for handmade goods, often referred to as the internet’s own flea market, was already under fire after Black and White Capital LP, an activist hedge fund with a 2% stake in the company, released a damning press release. In it, the investor accused the company of showing a “historical pattern of ill-advised spending”, and calling for the swift undertaking of strategic alternatives, including an all-out sale of the company.

Just as the press release gathered steam in the early hours of May 2, Etsy’s stock rose by almost 6.5% — perhaps in anticipation of some drastic corrective action to assuage the anxieties of the company’s investors. The corrective action did come, and quite swiftly — by mid-afternoon, Etsy’s leadership had been almost entirely reconfigured as the company announced the departures of its CEO Chad Dickerson and CTO John Allspaw.

Dickerson was also asked to step down as the chairman of the company’s board of directors; and here we come full circle because the person who now occupies the chair is Fred Wilson — the co-founder of Union Square Ventures, who, as this post mentioned earlier, had three years ago warned the tech industry about the inevitability of precisely this sort of outcome if tech companies continued to show a pattern of maverick spending.

Etsy has been criticized for spending $40 Million to renovate its “perk-filled” office.

With the prospect of a sale hanging over the company, and the twitterati adding fuel to the fire, the company came under the unsparing lens of the press even further. Its “splurges” — like its $40 Million office renovation, Yoga and arts-and-crafts classes, along with other perks — caught the attention of tech bloggers and journalists, who chided the company with headlines like “Play Time is Over”.

As it happens, WeWork, another unicorn startup which, in 2016, had to slash its profit forecast by 78% after losing control of its spending, faced the same kind of scrutiny. Ultimately, investors’ collective grievances, along with the mounting pressure of bad press, forced its CEO to come forward and announce cost-cutting measures like scrapping executive lunches, $350 breakfasts, and controlling electricity costs.

It’s unclear how Etsy will go about correcting its “historical pattern of ill-advised spending”. But any suggestions to penny pinch, cut costs or lay off even more employees would only be knee-jerk and reactive. Indeed, such temporary measures are symptomatic of tech’s collective ignorance about how to best solve the larger problem.

Are you having trouble managing you company’s spending? Procurify is helping hundreds of companies improve their bottom lines by giving them complete visibility and control over their spend. Book Your Free Consultation Today. 

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