What is the Burn Rate?
Burn rate is the amount of time it will take a company to exhaust its capital cushion.
How Does the Burn Rate Work?
Let's assume newly formed Biotech Company ABC has just been granted venture capital (VC) funds to pursue a groundbreaking new drug. The VC firm gives ABC a certain number of years to reach breakeven or even become profitable.
If Biotech Company ABC is spending $100,000 per month beyond what they are bringing in, they have a burn rate of $100,000 per month or $1.2 million ($100,000 x 12 months) per year. The VC firm knows that it will need to provide enough cash to cover that shortfall each period.
Why Does the Burn Rate Matter?
Investors look at the burn rate versus expected future revenues of a company to decide if it's worthwhile to invest in the firm. If the company's burn rate exceeds forecasts or if its revenues are not growing at a reasonable pace, it may be too risky to invest in the company. A company may reduce its burn rate by becoming more operationally efficient.
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