ARR to Headcount Ratio: The SaaS Gut Check

I used to get a question from SaaS companies during budgeting or fundraising season (one of which was always in season) about whether their financial projections “made sense.”

It’s tough to answer that question outside of calling out obvious issues like infinitely accelerating growth or industry-defying profit margins. However, with just a simple “gut check” benchmark metric you can turn an otherwise hand-wavy planning session into an operationally valuable exercise.

The simplest and most reliable benchmark “gut check” is the ARR to Headcount ratio.

I’ve written briefly on the topic before on Twitter.

What I noticed is no matter how big or small, fast growing or slow, SaaS companies tend to conform to a ARR to Headcount ratio of around $100k plus or minus $50k, meaning a $1M ARR business tends to have between 7 and 20 employees.

For earlier startups with outside funding but not much revenue, that number could be less than $50k. For seasoned bootstrappers with a few years of operating history I’ve seen it as high as $200k+.

The number will also vary based on ACV and sales model. For very low ACV self-serve models the sky’s the limit as it’s theoretically possible to run one of those with 1–2 people. For large 7-figure ACV models with 6–12 month sales cycles, the number could look very low in the early days as staffing up necessarily precedes closing sales.

One explanation for why the number settles in that $50k to $200k range is because each employee will typically cost you about that much in annual compensation. Achieving less than that in ARR per employee essentially means you are burning cash, and no one likes to burn cash for very long.

Another explanation is that SaaS companies run into a law of physics limiting how productive an individual SDR, sales rep, or account manager can be. There’s only so many hours in a day for them to be working leads. At a certain point the aggregate performance of the team will only scale by adding more (good) people, hence the linearity of the metric.

So back to the value of the $100k plus or minus $50k rule. The next time you build a forward projection model, check your ARR to Headcount ratio. If it exceeds $150k I would take another look at whether you’re assuming too much productivity out of your employee base. Being too far above benchmark on this metric is at least as bad as being too low.

If you’re too high on ARR to Headcount it means you’re likely to under-hire. If you under-hire it’s very hard to get back on track because you will have missed the required ramp up and sales cycle period to get new hires productive. Then you run the risk of missing your revenue targets, which can delay fundraising and possibly result in insolvency.

On the other hand if the metric is too low, it could mean you are burning too much cash (unless you have your labor force in a low cost part of the world) and that can’t go on forever. You would either need to make cuts or make everyone more productive. But at least you would have staff to work with as opposed to starting a search for staff, which is why I think it’s possibly worse to be too high on the benchmark than too low.

After experiencing the consequences of both types of errors up close I was inspired to create a benchmark dataset of SaaS metrics to avoid these issues. Beyond ARR to Headcount ratio there’s a few others I think are useful that I’ll write about in future posts.

Get in touch and let us know what you think!