A startup EDA company needs about $7M in bookings to become self-sustaining and not require another round of external funding. Curiously, it doesn’t seem to depend all that much on the product provided there is really a market out there, which, of course is by no means a given. And more funding can always be an accelerator to growth even if slow growth would have been possible without it.
The R&D team should be about 10 people. It will be less in the early days but it shouldn’t really be more unless the company truly must develop a range of products in parallel. With more than 10 people, engineering will be off developing a range of products even if that isn’t the plan!
With a CEO and another “person” in the form of an accountant, an office manager, a little marketing (they may be one person or more likely a few people part-time) that makes a total of 12-13 people, which is a fixed cost of around $2.5-3M per year. A single sales team is around $800K-1M per year as we saw earlier. With that headcount in place it takes about $3.5-4M to break even.
But a sales team only brings in $2M so $3.5M is more than one sales team can bring in so we need a second, at another $800K-1M pushing the breakeven up to $4.5M. This is just about doable but more likely a third sales team will be required, pushing revenue to $6M and expenses to $5.5M. Add in some inefficiencies in training salespeople, filling the funnel and the rule of thumb is that you need to get to about $7M to become cash-flow netural and the company start to be able to fund its own growth, albeit slowly.
But breakeven isn’t the end goal, being profitable enough to have options is. Then we can be acquired, or continue to grow the business or even just pay our shareholders nicely out of the profits. This means getting the business up to about $10-11M, which means about 5 sales teams. The 5 sales teams will cost about $4-5M, leaving $6M. That will pay the $3M original (non-sales) fixed cost with $1M for some additions to the corporate team: a marketing person, maybe some non-bag-carrying sales management, and after a couple of years somebody might want a pay raise. That leaves $2M to either take as profit or use to fund further growth, start a second product and so on.
All of this makes one big assumption. That the product is really ready at the point that the channel expenses are ramped up. It assumes that each salesperson rapidly makes it to the $2M per sales team level. This is where companies die though. If the sales teams are added too early then they will burn all the cash. If the product is not ready for the mainstream then the sales guys will not make it to the $2M level and burn all the cash. But if everything is in place then the company can get to $10M rapidly. The first year I was at Ambit we did $840K in revenue; the second year, $10.4M.
This is the point at which a company is very attractive for acquisition. It has traction in the market ($10M in sales and growing), the technology is proven (people are using lots of it; look, $10M in sales), the acquisition price hasn’t got too expensive yet (only $10M in sales), it is probably the market leader in its niche ($10M in sales and growing). Of course if the company continues to grow it will typically take in more investment at this point in order to grow even faster. Value of a software company is some multiple of forward earnings, and the greater the growth the greater the multiple.