Valuing a SaaS company can be challenging, but it is essential to ensure a sound investment, as well as for sellers and buyers to determine the fair market value. In this guide, we will explore the key metrics, methods, and factors that impact SaaS company valuation.
SaaS companies are software-as-a-service businesses that provide cloud-based solutions to customers. The SaaS industry has been growing rapidly, with a projected market size of $220 billion by 2022.
However, valuing a SaaS company can be complex due to the unique characteristics of the SaaS business model.
In this article we’re going to study:
- How to measure SaaS valuation
- How to increase SaaS valuations
- How to sell a SaaS
Importance of Valuing a SaaS Company
Valuing a SaaS company is essential for several reasons:
- For investors, it helps determine the fair market value of the company and whether it is a sound investment.
- For sellers, it helps determine the asking price when selling the company.
- For buyers, it helps determine the fair price to pay for the company.
In this guide, we will cover the following topics:
- Understanding SaaS Company Valuation Metrics
- Different Ways to Value a SaaS Company
- Factors That Impact SaaS Company Valuation
- SaaS Metrics That Impact Valuation
- How to Increase the Value of a SaaS Company
- Conclusion
Now, let’s dive into the first topic: understanding SaaS company valuation metrics.
SaaS Company Valuation Metrics
Valuing a SaaS company involves understanding various metrics that impact its financial performance and growth potential. Here are the key SaaS company valuation metrics:
Churn
Churn rate is the percentage of customers who stop using a company’s product or service during a given period.
A high churn rate can negatively impact the valuation of a SaaS company as it indicates that customers are not satisfied with the product or service.
Customer Acquisition Cost (CAC)
CAC is the total cost of sales and marketing expenses needed to acquire a new customer.
A high CAC can impact the valuation of a SaaS company as it indicates that the cost of acquiring new customers is high, which can impact the profitability of the business.
Lifetime Value (LTV)
LTV is the total revenue generated from a customer over their lifetime.
A high LTV can positively impact the valuation of a SaaS company as it indicates that the company has a loyal customer base that generates significant revenue over time.
Monthly Recurring Revenue (MRR) vs. Annual Recurring Revenue (ARR)
MRR is the total revenue generated from monthly subscriptions, while ARR is the total revenue generated from annual subscriptions.
ARR is preferred over MRR as it provides more predictable revenue, which can positively impact the valuation of a SaaS company.
Year-over-Year (YoY) Growth Rate
YoY growth rate is the percentage increase in revenue or other key metrics from one year to the next.
A high YoY growth rate can positively impact the valuation of a SaaS company as it indicates that the company is growing rapidly.
Scalability
Scalability is the ability of a SaaS company to grow its revenue without significant increases in costs.
High scalability can positively impact the valuation of a SaaS company as it indicates that the company can grow rapidly while maintaining profitability.
Total Addressable Market (TAM), Serviceable Addressable Market (SAM), and Serviceable Obtainable Market (SOM)
- TAM is the total market size for a given product or service
- SAM is the portion of TAM that a company can realistically target
- SOM is the portion of SAM that a company can realistically obtain
A high TAM, SAM, and SOM can positively impact the valuation of a SaaS company as it indicates that there is significant growth potential for the business.
Valuation Formula
The valuation formula for a SaaS company typically includes metrics such as ARR, growth rate, net revenue retention, and gross margin.
The net revenue retention metric measures the percentage of revenue retained from existing customers over time.
The gross margin metric measures the percentage of revenue remaining after deducting the cost of goods sold.
The valuation formula can vary depending on the business model, industry, and other factors.
Avoiding General Market Valuation and Comparisons with Competitors or Public SaaS Companies
Valuing a SaaS company based on the general market or comparing it with competitors or public SaaS companies can be misleading as each company has unique characteristics and metrics that impact its valuation.
It is essential to use a valuation formula that considers the specific metrics and characteristics of the SaaS company being valued.
The Rule of 40
The rule of 40 suggests that a SaaS company’s combined growth rate and profit margin should be over 40% for a sound investment.
This rule can help investors determine whether a SaaS company has a sustainable growth engine with a profitable future.
Now that we have covered the key SaaS company valuation metrics, let’s move on to the different ways to value a SaaS company.
Source: SaaS Academy
Recommended Lecture: Important metrics to track in SaaS
Different Ways to Value a SaaS Company
Valuing a SaaS company can be challenging as there are different methods for determining the fair market value.
Recommended Lecture: SaaS Venture Capital Investing
Here are the three primary ways to value a SaaS company:
Revenue-based Valuation
Revenue-based valuation is a method that takes into account a SaaS company’s revenue to determine its fair market value.
It includes metrics such as MRR, ARR, and growth rate to estimate the future revenue of the business.
Revenue-based valuation can be calculated using multiples such as revenue multiple, enterprise value to sales (EV/Sales), and price-to-earnings ratio (P/E ratio).
SDE-based Valuation
SDE-based valuation is a method that takes into account a SaaS company’s seller’s discretionary earnings (SDE) to determine its fair market value.
SDE is the total income generated by the business, including salary, bonuses, and other perks, minus the expenses required to generate that income. SDE-based valuation can be calculated using multiples such as SDE multiple and EV/SDE.
EBITDA-based Valuation
EBITDA-based valuation is a method that takes into account a SaaS company’s earnings before interest, taxes, depreciation, and amortization (EBITDA) to determine its fair market value.
EBITDA is a measure of a company’s profitability that excludes non-operational expenses such as interest and taxes. EBITDA-based valuation can be calculated using multiples such as EBITDA multiple and EV/EBITDA.
Factors to Consider
When valuing a SaaS company, it is essential to consider other factors that impact its fair market value. These include:
Industry
The industry in which a SaaS company operates can impact its fair market value. For example, a SaaS company operating in a highly competitive industry may have a lower fair market value than a SaaS company operating in a niche industry.
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Business Model
The business model of a SaaS company can impact its fair market value. For example, a SaaS company with a subscription-based business model may have a higher fair market value than a SaaS company with a one-time purchase business model.
Recommended Lecture: Vertical vs Horizontal SaaS
Value Proposition
The value proposition of a SaaS company can impact its fair market value. A SaaS company with a unique value proposition may have a higher fair market value than a SaaS company with a generic value proposition.
Ideal Customer Profile
Having a well-defined ideal customer profile can impact the fair market value of a SaaS company. A SaaS company with a clear understanding of its target market may have a higher fair market value than a SaaS company with a broad target market.
Now that we have covered the different ways to value a SaaS company and the factors that impact its fair market value, let’s move on to the metrics that impact SaaS company valuation. Source: Kalungi
Recommended Lecture: SaaS B2B
Metrics That Impact SaaS Company Valuation
Valuing a SaaS company involves analyzing various metrics that impact its financial performance and growth potential. Here are the key SaaS company metrics that impact its valuation:
Churn Rate
Churn rate is the percentage of customers who stop using a company’s product or service during a given period. A high churn rate can negatively impact the valuation of a SaaS company as it indicates that customers are not satisfied with the product or service.
Customer Lifetime Value (LTV)
LTV is the total revenue generated from a customer over their lifetime. A high LTV can positively impact the valuation of a SaaS company as it indicates that the company has a loyal customer base that generates significant revenue over time.
Customer Acquisition Cost (CAC)
CAC is the total cost of sales and marketing expenses needed to acquire a new customer. A high CAC can impact the valuation of a SaaS company as it indicates that the cost of acquiring new customers is high, which can impact the profitability of the business.
Monthly Recurring Revenue (MRR) and Annual Recurring Revenue (ARR)
MRR is the total revenue generated from monthly subscriptions, while ARR is the total revenue generated from annual subscriptions. ARR is preferred over MRR as it provides more predictable revenue, which can positively impact the valuation of a SaaS company.
Gross Margins
Gross margins are the percentage of revenue remaining after deducting the cost of goods sold. High gross margins can positively impact the valuation of a SaaS company as it indicates that the company has low costs and can generate significant profits.
Net Revenue Retention
Net revenue retention is the percentage of revenue retained from existing customers over time. A high net revenue retention rate can positively impact the valuation of a SaaS company as it indicates that the company has a loyal customer base that generates significant revenue over time.
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Age of the Business
The age of a SaaS company can impact its valuation. A young SaaS company may have a lower valuation than an older SaaS company as it may not have a proven track record of revenue and profitability.
Funding Status
The funding status of a SaaS company can impact its valuation. A SaaS company that has raised significant funding may have a higher valuation than a SaaS company that has not raised any funding.
Scalability
Scalability is the ability of a SaaS company to grow its revenue without significant increases in costs. High scalability can positively impact the valuation of a SaaS company as it indicates that the company can grow rapidly while maintaining profitability.
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Intellectual Property
Having strong intellectual property rights can positively impact the valuation of a SaaS company as it indicates that the company has a competitive advantage in the market.
Customer Experience
Providing a great customer experience can positively impact the valuation of a SaaS company as it indicates that the company has a loyal customer base that generates significant revenue over time.
Now that we have covered the metrics that impact SaaS company valuation, let’s move on to the factors that can increase the value of a SaaS company.
Source: FE International
How to Increase the Value of a SaaS Company
Increasing the value of a SaaS company can be achieved by focusing on several key areas of the business. Here are the factors that can increase the value of a SaaS company:
Ideal Customer Profile
A SaaS company with a clear understanding of its target market can improve its product or service to meet the needs of its customers, resulting in increased customer satisfaction and retention.
Messaging and Positioning
Solid messaging and positioning can increase the value of a SaaS company as it helps the company stand out in a crowded market. A SaaS company with a strong value proposition and brand messaging can attract more customers and increase its revenue.
Customer Acquisition Channels
A SaaS company with a diversified customer acquisition strategy can reduce its reliance on a single channel and increase its revenue through multiple channels.
Intellectual Property Protection
A SaaS company that has secured intellectual property rights can prevent competitors from copying its product or service, resulting in a competitive advantage and increased valuation.
Pricing Optimization
A SaaS company that has optimized its pricing strategy can increase its revenue and profitability, resulting in a higher valuation.
Marketing Infrastructure
A SaaS company with a well-defined marketing strategy, marketing automation tools, and a strong sales team can improve customer acquisition and retention, resulting in increased revenue and a higher valuation.
Customer Experience
A SaaS company that provides a great customer experience can increase customer satisfaction and retention, resulting in increased revenue and a higher valuation.
Documentation and Standardization
A SaaS company with documented and standardized processes can improve efficiency and reduce costs, resulting in increased profitability and a higher valuation.
Outsourcing
A SaaS company that outsources non-core functions can reduce costs and focus on its core competencies, resulting in increased profitability and a higher valuation.
Now that we have covered the factors that can increase the value of a SaaS company, let’s move on to the options for selling a SaaS business.
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Options for Selling a SaaS Business
Selling a SaaS business can be a complex process, and there are several options available to business owners. Here are the most common options for selling a SaaS business:
Broker
Using a broker is the most common option for selling a SaaS business, especially for larger businesses. A broker can help business owners to determine the value of their business, find potential buyers, and negotiate a deal. Brokers typically charge a commission based on the sale price of the business.
Investment Banker
An investment banker can help business owners to sell their SaaS business to a larger company or private equity firm. Investment bankers typically work with larger businesses and charge a higher fee than brokers.
Direct Sale
A direct sale involves the business owner selling the business to a buyer without the help of a broker or investment banker. This option is typically only suitable for smaller businesses or businesses with a small number of potential buyers.
Employee Stock Ownership Plan (ESOP)
An ESOP is a retirement plan that allows employees to own a portion of the company. This option is suitable for business owners who want to sell their business to their employees and ensure that the business continues to operate under employee ownership.
Initial Public Offering (IPO)
An IPO is a process in which a private company goes public by selling shares of stock to the public. This option is typically only suitable for larger SaaS businesses with a proven track record of revenue and profitability.
Now that we have covered the options for selling a SaaS business, let’s move on to the key takeaways from this guide.
Source: Eqvista
Valuing a SaaS Company Wrapping Up
Valuing a SaaS company can be a complex process, but understanding the key metrics and factors that impact valuation can help business owners to increase the value of their business. By focusing on areas such as customer acquisition, intellectual property, pricing, and customer experience, business owners can improve the financial performance and growth potential of their SaaS company.
When it comes to selling a SaaS business, there are several options available, including using a broker, working with an investment banker, selling the business directly, or exploring an ESOP or IPO.
We hope that this comprehensive guide to valuing a SaaS company has been helpful for you. If you want to learn more about SaaS businesses, be sure to check out our other great content.
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Valuing a SaaS Company Frequently Asked Questions
Who can benefit from a comprehensive guide to valuing a SaaS company?
Business owners, investors, and entrepreneurs can benefit from this guide.
What are the key metrics for valuing a SaaS company?
Metrics such as churn, CAC, and LTV are key for valuing a SaaS company.
How can I increase the value of my SaaS company before selling?
By focusing on areas such as customer acquisition, intellectual property, pricing, and customer experience.
What are the options for selling a SaaS business?
Options include using a broker, investment banker, direct sale, ESOP, or IPO.
How can I accurately determine the value of my SaaS business?
Speak with a broker or investment banker to accurately determine the value of your SaaS business.
What should I avoid when valuing a SaaS company?
Avoid valuing based on general market or comparing with competitors or public SaaS companies.
But what if I don’t have a well-defined customer profile?
Developing a well-defined customer profile can increase the value of your SaaS company, so it’s important to focus on this area.
