Look How Big My Team is!

I'm used to getting asked how many employees work at my startup. For most people, it's a quick way to assess a startup's success. Supposedly, the bigger, the better. But does it really reflect success? 

To cut to the chase, headcount is a lousy metric. Paul Graham has a great tweet that says: "When people visit your startup, they should be surprised how few people you have. A visitor who walks around and is impressed by the magnitude of your operation is implicitly saying, "Did it really take all these people to make that crappy product?" I agree with him, and I'm often surprised by how many people and how much capital it has taken to build mediocre businesses. Headcount is a vanity metric similar to followers on social media or fundraising amount.

Plenty of examples exist where small teams outcompete large teams in the same market.

Small teams leverage speed as a competitive advantage, which is key to winning over competitors. Other benefits include better communication, more engagement, more profits to reinvest, and, overall, better productivity. Small groups avoid the Ringelmann effect, which is the tendency for individuals to become increasingly less productive as the size of their group increases. More importantly, the headcount constraint drives creativity and innovative solutions. Inflating one's team is frequently a bad idea because throwing more people at a problem doesn't solve the problem faster. 

It often leads to what I call the "hiring death cycle." A startup faced with a problem tends to hire more people, making it harder to solve the problem and thus requiring even more hires. The death cycle is reinforced by the "next hire fallacy," in which, supposedly, the next recruit will suddenly solve the problem. It's common to fall into this vicious cycle, and hard to break out of it. 

Controlling headcount expansion when experiencing fast growth is challenging. Targeting an efficient number of teammates is tricky because it's difficult to know and test when fewer people can achieve more. Additionally, managers have an incentive to grow headcount as it means more responsibility, prestige, and better compensation. Entrepreneurs and investors often push to hire more as it gives an impression of faster progress. However, the key is to focus on the business's performance over time. 

An excellent way to assess the efficiency of a business is to compare its revenue to the number of employees. The best companies increase their revenue per employee as they scale, making their revenue grow faster than their costs. One of the critical metrics for SaaS startups is the annual recurring revenue (ARR) divided by full-time employees (FTE). For instance, the median ARR per FTE ratio for private SaaS startups in the $10-$20M revenue range is $138,889. The same benchmark exists for all publicly traded SaaS, with the median being $260,045. The benchmark exemplifies that great companies always increase their ARR/FTE over time. 

So, one of the few reasons to ask for the startup headcount is to compare it with its revenue and quickly evaluate its soundness. Say a fast-growing SaaS startup has 80 employees and $15M in annual recurring revenue. It implies an excellent $187,500 ARR/FTE ratio, and it's likely a fantastic business. Voilà! You can now better assess the success of most startups.