Two million per salesperson

There is a rule of thumb that all EDA executives know (or have to learn expensively), which is that an EDA company thrives if its sales teams bring in $2M per salesperson. So a medium sized company with, say, 4 salespeople should have a booking forecast of around $8M and each salespersons quota should be about $2M.

For now let’s ignore the difference between booking and revenue. Startups don’t actually care about revenue that much, they care about cash. And cash comes a quarter later. The typical deal means that a startup must fund a sales team for the quarter, they close a deal in the last week, and the company receives cash in the middle of the following quarter. That time-lag, between the investment in the team and collecting the cash, is one of the main things for which series B investment money is needed. VCs have a phrase “just add water” meaning that the product is proven, the customer will buy at the right price. It should be a simple case of adding more money, using it as working capital to fund a bigger sales team and to cover the hole before the bigger sales team produces bigger revenue and pays for itself.

Where does this $2M rule come from? A successful EDA company should make about 20% profit and will require about 20% revenue to be spent on development. Of course it is more in the early stage of a startup, most obviously before the product is even brought to market but even through the first couple of years after that. Let’s take another 20% for marketing, finance, the CEO and so on. That leaves 40% for sales and application engineers. The other rule of thumb is that a salesperson needs two application engineers, either a dedicated team or a mixture of one dedicated and one pulled from a corporate pool. If a salesperson brings in $2M then that 40% for sales and applications amounts to $800K, A fully loaded application engineer (salary, bonus, benefits, travel) is about $250K. A fully loaded salesperson is about $300K (more if they blow away their quota). So the numbers add up.  If the team brings in much less than $2M, say $1½M, then they don’t even cover the costs of the rest of the company, let alone leave anything over for profit.

One consequence of the two million dollar rule is that it is hard to make a company work if the product is too cheap, at least in the early days before customers will consider large volume purchases. To make $2M with a $50K product, if you only sell two licenses at a time, is one order every two or three weeks. But, in fact all the orders come at the end of the quarter meaning that the salesperson is trying to close five deals with new customers at the end of each quarter, which will likely be impossible.

Of course, if a salesperson is new then they won’t be able to achieve this. They have two strikes against them. Strike one, they don’t know the product well enough to do an effective job of selling it. Strike two, they don’t have a funnel of potential business as various stages of ripeness, from potential contacts, first meetings, evaluations and so on. So when a company is growing, hiring new people, the $2M quota is simply unrealistic. Even more money will be needed to cover the gap between starting to pay for a sales team until they are bringing in enough money to fund themselves.

I’ve put together no end of business models for software companies and the critical assumptions are always how long it takes a new salesperson to bring in any business, how fast they then ramp to the $2M level, and how many application engineers they need. You then can almost read the funding requirement off the spreadsheet.