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)
