Bankroll and Burn Rate

How much money do I need?

Whether you're on your way to your local casino or getting ready to travel to a tournament, it's probably the first question you ask yourself. In poker and business, losing money is part of the game. Having enough money is the name of the game.

When you're trying to figure out how much you need, you think about the stakes and the likely swings. You'll also want to know if you can get more cash once you're there – whether that means there's someone in the game who will give you a loan or simply that there's an ATM machine nearby. You may also consider how much you can afford to lose – financially and emotionally. Because the biggest fear of most poker players is the thought of running out of money, you'll likely bring as much as you can.

In business, there is a cost to this mentality. When you raise money, you'll either have to take on debt or sell equity. And while having more than you need may set you at ease, you run the risk of burdening yourself with debt payments or giving up too much equity in your business.

Before raising money, an entrepreneur will likely ask, "What's the burn rate?" If a business "burns" $50,000 a month, it's easy enough to figure out that it needs $600,000 to survive for one year. But where does that number come from? It's not enough to say that it's the most likely scenario or even the worst-case scenario; you have to know the likely fluctuations.

Knowing the fluctuations, also called the standard deviation, tells you the variability of the outcomes. In other words, what range the outcomes will fall within.

If your mean (average) win rate is $50 an hour and you play for 100 hours, you are expected to win $5,000. If your standard deviation is $500, you can expect to lose no more than $1,450 and win no more than $1,550 in an hour, since 99 percent of outcomes fall within three standard deviations of the mean. Over the course of 100 hours of play, you could be winning as much as $20,000 and losing as much as $10,000. So, if you needed to raise money for a two-week trip, raising less than $10,000 would put you at risk of going broke, and raising more would mean incurring unnecessary borrowing costs.

Just as a poker player can quantify how much of a swing he is likely to have by calculating a standard deviation, a business should do the same. When businesses run short of cash, everything revolves around paying the bills, instead of running the business efficiently. The consequences range from borrowing at an exorbitant rate, to giving up too much equity, to excessive discounting. Having a financial cushion allows you to focus on the business and not panic when things go wrong. It's possible that you can open a car wash only to see it rain 20 consecutive days. Or, you can open a restaurant, and on opening night someone gets food poisoning and you're shut down for two weeks. On an even bigger scale, imagine that your breakthrough drug gets tampered with and you have to pull it from the shelves. If you're Tylenol and you have the financial resources, you can regroup. If you're an undercapitalized start-up company, you're toast.

Determining the fluctuations in your business isn't just to prevent you from going broke. Just as things can go worse than expected, they can also go better than expected. What happens if you raise $600,000 by selling 25 percent of your equity and you make a big sale much earlier than you anticipated? You just can't return the money to your investors and ask for your equity back. That's why established businesses set up a line of credit with a bank, whereby they pay interest only on the amount of money they borrow – not the entire amount that's set aside.

For a new business, which doesn't have the track record or collateral to establish a line of credit, it's not sufficient to compute your burn rate or rely on a gut feeling to decide how much money you should raise. Sure, you need a cushion, and performing specific projections is the only way to know how much. But by estimating your fluctuations, you can stagger your funding so that you don't have to give up any more equity than necessary.

Preparing for the worst-case and best-case scenarios means projecting the fluctuations in your business. The proper balance means not having to worry about bankruptcy without giving up too much equity.

Greg Dinkin is the author of The Poker Principle: Winning in Business No Matter What Cards You're Dealt, which will be published by Crown in April 2002. He is also the co-founder of Venture Literary (www.ventureliterary.com), where he works with writers to find publishers for their books and producers for their screenplays.