Why Do Startups Grow by Burning Cash—or Not Grow at All?
To explain the phenomenon of cash burn in startups, let’s focus on a few basic concepts:
1. The Balance Between Supply and Demand
First, it’s important to understand that supply and demand are linked through price. Simply put, the higher the price of a product or service, the more suppliers will want to offer it (after all, who doesn’t want to make more money?). On the other hand, the higher the price, the lower the demand, since no one likes paying more than necessary.
To ensure that the quantity supplied of a good matches the quantity demanded—meaning, avoiding shortages or oversupply—there must be an equilibrium price where the value generated is maximized.
For example:
If an ice cream costs R$2.00, 150 people want to buy it, but only one company is willing to sell at this price, resulting in scarcity—many people won’t get their ice cream.
If the ice cream costs R$1,000.00, many companies will want to sell it, but very few people will be willing to buy.
There is a price R$P.00 where the number of sellers and buyers is equal—this is the equilibrium price.
2. Price Composition
If we assume that companies set the price of their products, the price formula looks like this:
PRICE=(COST+MARKUP)×(1+TAX)PRICE = (COST + MARKUP) \times (1 + TAX)PRICE=(COST+MARKUP)×(1+TAX)
In other words, the price includes:
The production cost of a good or service
The company’s desired profit margin (markup)
Taxes, which we’ll assume are fixed for simplicity
3. Definition of Profit
In simple terms, profit is the difference between a company’s revenue and its costs (production, administrative, debt, taxes, etc.):
PROFIT=REVENUE−COSTSPROFIT = REVENUE - COSTSPROFIT=REVENUE−COSTS
4. Definition of Revenue
A company’s revenue (or sales) is the result of the number of units sold multiplied by the price per unit:
REVENUE=PRICE×QUANTITYSOLDREVENUE = PRICE \times QUANTITY SOLDREVENUE=PRICE×QUANTITYSOLD
5. Growth Rate
Assuming growth means an increase in revenue, a startup must invest capital in three main areas:
Product
Sales
Marketing
These investments are not made in isolation and don’t follow a fixed formula, since each company operates differently (PLG, SLG, etc.).
The expected growth rate for a startup is, on average, 100% per year—meaning, doubling in size annually for several years.
Conclusion
For a startup to grow rapidly, it must scale its operations.
Scaling operations → increases costs
To increase costs, the company needs cash
To have cash, the company must be profitable
To be profitable, revenue must exceed costs
To increase revenue, the company must sell more units and/or raise prices
However, to maintain high demand, prices can’t increase too much (or at all)
Since costs increase and taxes are fixed, the only way to keep prices low is by reducing markup (profit margin)
Because growth rates are so aggressive, costs tend to rise faster than revenue
When costs exceed revenue, the company incurs losses (negative profit)
If the company loses money, it doesn’t generate cash
Without cash generation, the company needs external capital to fund operations
This capital usually comes from venture capital funds (VCs)
VC money goes into the company’s cash reserves to fund rising costs and support aggressive growth rates
If the company spends more cash than it generates, it burns cash—meaning its cash reserves shrink every month
Startups either grow by burning cash—or they don’t grow at all.
Extra 1: Growth Investments Aren’t Always Linear
Investments in product, marketing, and sales don’t always generate proportional returns. Increasing spending by R$1.00 doesn’t necessarily lead to R$1.00 in additional revenue—in fact, returns tend to diminish over time.
As operations inflate, they become less efficient, leading to higher losses.
When startups reach stagnation—where growth slows or stops regardless of investment—they resort to layoffs. Layoffs are simply cost-cutting measures to rebalance expenses and revenue (i.e., reach zero profit).
Extra 2: The Importance of Break-Even
Break-even is the point where profit = zero, meaning revenue matches costs.
It’s highly celebrated today because it allows a startup to survive without investor money, which is currently scarce.
From an investor’s perspective, however, break-even is bad because it often means the company isn’t growing fast enough, reducing the chances of high investment returns.
However, break-even lowers the risk of failure, giving the company more time to raise new funding when market conditions improve—increasing the chances of long-term success.
About the Author
Renan Mittelstaedt is an economist from Insper with a well-established career in the technology sector. He started as a venture capital investor and technology consultant, working in Silicon Valley at Plug and Play Tech Center and in Brazil at Provence Partners. After years as an executive, he decided to become an entrepreneur and founded EasyGroup, a consulting firm specializing in technology infrastructure and software development for large enterprises. With hands-on experience in technology, innovation, and business, Renan shares insights about the industry through his articles and publications.