Updated: Jul 16
Will your startup really make more money per employee than Apple? Maybe!
One problem we have as entrepreneurs is that VCs look at a ton of startup financial projections...but we pretty much only look at our own. That creates a huge information disadvantage for us.
How can we confidently present our startup financials to someone who's looks at a thousand of them each year? Won't they be able to sniff out unrealistic assumptions at a glance?
We want to make our financial model as realistic as possible (for ourselves and our employees too—not just for potential investors). Is there a way to sanity check our assumptions?
Yes! There are several methods that I use (including starting with a professional startup financial projection template).
Here's a quick walk-through of the revenue per employee concept:
One of my sanity-checking secrets is revenue per employee. This also gives us the superpower of knowing about how many people to hire each year! Let's see how...
The math is simple: take total earnings for the year and divide it by the number of employees.
Notice that when we say "Average Revenue per Employee" what we really mean is "Average Revenue per Employee per Year."
Here’s an example for a tech company:
Year 1 revenue = $2 million, headcount at end of year = 22
Year 2 revenue = $8 million, headcount at end of year = 25
Year 3 revenue = $24 million, headcount at end of year = 30
So revenue per employee is as follows:
Year 1 = $91k average revenue per employee
Year 2 = $320k average revenue per employee
Year 3 = $800k average revenue per employee
Is it Realistic?
Do I think this is believable? I use $200k per employee as a starting point for reasonable assumptions—meaning five employees per every million dollars in revenue—so I suspect that year 3 is unrealistic.
Let’s compare with established tech companies (source: Business Insider with what I think are numbers from 2014):
IBM = $244k average revenue per employee
Amazon = $577k average revenue per employee
Microsoft = $732k average revenue per employee
Google = $1,155k average revenue per employee
Apple = $1,865 average revenue per employee
Tim Cook enjoying the fact that Apple earns so much revenue per employee
$800k revenue per employee in year 3 puts this company past Microsoft and on their way to Google. Is this realistic?
Maybe…I do know a ten-employee business that does nine figures…but is it likely?
Looking at this makes me think that this company may have to hire more people in year 3.
The same is true in reverse. If year 3 revenue per employee is $50k, I wonder why this business isn’t more efficient. Have they hired too many people?
It's okay for startups that are raising money to have low revenue per employee in the first few years—that's why they're raising the money. Eventually, though, they need to figure out how to become efficient in terms of revenue per employee. That's why I like to target $200k to $600k revenue per employee in year 3.
Our New Superpower: We Know How Many People to Hire
One of the questions I get most often at Rocket Pro Forma is, "How many people should I hire?"
First, you can check out my article on your startup hiring plan made simple.
Second, we can use the information we have to reverse-engineer how many people to hire each year. Let's use this example:
We can see that we're below our $200k minimum in year 1, but that's okay if we're raising money.
In years 2 and 3 we can see that average revenue per employee rockets past Microsoft and Apple. Is that realistic?
If anything, startups that raise money would have artificially low revenue per employee numbers (because they're using investor money to hire more people than they could otherwise afford).
How can we fix this?
Let's target $300k per employee in year 2. If we take our year 2 revenue of $6.840 million and divide it by $300k we get 22.8 employees. But we can't hire .8 of a person, so we round up to 23. We then divide $6.840 million by 23 employees to get $297k.
Like magic we now know how many people to hire in year 2!
Now let's assume that we get more efficient, so let's target $400k per employee in year 3. If we take our year 3 revenue of $12.588 million and divide it by $400k we get 31.5 employees. But we can't hire .5 of a person, so we round up to 32. We then divide $12.588 million by 32 employees to get $393k.
Here's our new hiring plan—which has been sanity-checked for both ourselves and potential investors:
Headcount is a moving target so I like to just use the number of employees at the end of the year. This is inaccurate (we should technically divide by the average number of employees over the course of the year) but it has the advantage of being easy to compare with info from publicly traded companies.
Also, it is possible to hire .8 of a person if we include Full-Time Equivalents (FTEs). The gig economy has blurred the lines between who exactly is an employee, and how we calculate revenue per employee. We might find revenue per FTE to be more accurate for certain businesses.