Dear SaaStr: Why Do So Many Startups Burn Through So Much Cash?

Dear SaaStr: Why Do So Many Startups Burn Through So Much Cash?

Competition.

For most software / internet companies, the gross margins approach 80%. That means for every $10 you bring in, you get to keep at least $8 for payroll, etc. after paying off expenses.

In the early days, that’s not a lot of money. You may need to work for a $0 salary, sacrifice, skimp, borrow money from mom and dad, etc.

But as you approach a few million in revenues — the power of those 70–80% margins should kick in — and two things should start to happen:

  • you should start to generate material cash, absent other outsized increases in expenses;
  • you should finally have a brand, or at least a mini-brand in your space, and that brand should start to bring you in ever more prospects and customers, making it even easier to grow and mint even more cash.

Unless …

Your sales and marketing costs are very high.  And in SaaS, they usually are.  100% of more of your first year’s revenues per customer, and 50% or more of your total revenues.  

Sales and marketing costs can be high for two reasons. First, driving up your win rate, especially when there is a lot of competition, makes sales more expensive. And often drives prices down, up to a point. Competition also means you lose more deals. Fewer of your leads close. That, in effect, drives your marketing costs up as well.

Second, going for a “land grab” and entering as many segments of the market, even those where you lack a brand and/or the most competitive solution, is very expensive from a marketing/sales perspective.

When the competition is weak, sales and marketing expenses aren’t that high.

But these expenses grow dramatically in hyper-competitive markets.

Look at Atlassian or Qualtrics or SurveyMonkey. They grew more slowly in the beginning, being bootstrapped, but then minted cash after they hit millions in revenue. And importantly — they didn’t enter sales & marketing driven death matches with the competition.

(note: an updated SaaStr Classic answer)

 

Published on November 2, 2022

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