I read an interesting article about the core metrics of a business being a better way to measure real value than traditional assets or EBITDA. So I thought I'd share some of the components we use to value companies.
We haven't quite gotten this down to a science yet, but there is more to SaaS valuations than just revenue x growth (or a multiple of profit if you're in the everyday business world!).
Valuing a business does tend to be an emotional thing; probably one of the reasons M&A bankers exist — to be an impartial party that sets founders expectations on reasonable valuations for their business. On the buyer side — I think people always want to be fair but naturally want to do their job well, which means getting a price that de-risks the acquisition as quickly as possible (as opposed to paying a very high premium and the requirement becomes out-performance just to break-even on the purchase).
So, here are some considerations when it comes to buying or selling a SaaS business.
1. Total Revenue
First of all, and most obviously, the top line amount of revenue the company generates matters. At below $2m annually, there isn't enough cash flow to staff a team and grow a business, so there is a discount implicit in the 'hassle' factor. For most buyers, anything under 10m is an instant non-starter, and even then, the universe of buyers only opens up in the multiple '10's of millions in revenue. A buyer wants the revenue, and team, to be sizable enough to be stable and relatively self-managing. Smaller companies create a lot more risk.
2. Revenue Quality
Segmenting the customer base also matters. Suppose it is predominantly in one small market. There is concentration in a few large customers . In that case, the risk of substitution or shrinkage is high if something fundamental in the industry changes. The gold standard is a good spread of customers across industries, locations, industry types, contract sizes, and companies.
The most apparent value driver is growth to determine valuation multiples. The pinnacle of this is high growth from a larger revenue base — because it is easier to grow faster from a smaller number but much harder to keep up this pace as the total revenue grows. A simple rule of thumb is— flat to 20% year on year growth is likely to be a detractor, 20–40% is a solid median for fair-value based on the other metrics, and between 40–60% growth, or more, should yield a valuation increase (the amount will be dependent on your total revenue).
4. Installed Base Health
The health of a company's installed customer business is a critical valuation metric. If the existing customer base is happy, churn is under control (sub 2% a month gross cancellations), and the net movement is flat or positive (being — upgrades minus downgrades and churn), this brings a stable customer and revenue base. On the other hand — if the installed base is shrinking, and new customers are needed to stay flat, this is ultimately a poor end-state for a business, and even with growth, more and more of the new company acquired is required to plug the gap and stay flat. So NPS is also a great metric as a happy customer base is more likely to be a healthy one.
5. Customer Acquisition
Is the pipeline growing, with healthy conversion rates from visitors to MQL to SQL to Quote to Close? Are customer acquisition costs under control, well managed (and understood)? Is there a provably scalable funnel or set of levers to increase lead flow? If the acquirer can get confidence that predictable growth is baked into the business, it will help bring a deal over the line.
6. Team and Culture
Put yourself in the shoes of the buyer. How easy will working with this team be for a new owner or within another entity? Is the team excited about the transition and future opportunities? Is the team solid enough to sustain some of the natural churn that occurs in any significant change? When the acquirer talks to the executives and key team members , will they walk away happy or feel like their work is cut out?
A leaner team creates more risk, a lot more risk, which is another reason why most small companies struggle to find buyers. Distributed teams also struggle to find buyers — as the hassle factor of onboarding people that are not in one place creates a set of unknowns and a lot of additional work.
7. Market Position
Is there a super dominant player in your category? Is your business dependent on another platform? Is the space you are in generally growing (and at what pace)? What does the future look like for this sector? How many competitors are there? Where does your business realistically stack up in the competitive landscape, and does your market share validate that?
Ultimately, or in a leadership position, companies winning in an emerging or fast-growing market command a premium. , Suppose you have ten other competitors with reasonably similar products. The market is well defined (like Project Management). In that case, it will be hard to get a buyer excited about paying a premium. These things are true — they will result in a discount from base value because of the risk factors undifferentiated businesses bring with them.
What are other public companies in your space trading at? The Techcrunch article that talks about a competitor being acquired for ten or 20x is irrelevant. They are lottery ticket exits — hopefully with some strategic logic behind them. Instead, look at a comparable public company. It may be growing slower, but a public company is likely also a lot larger in revenue — so it's an excellent proxy to sense check against.
You could probably use these levers to develop a weighted model that gives a ball-park valuation for your company or one 'you'd like to acquire. But, of course, every company tends to throw up some rule break that 'doesn't fit the model — so apply a bit of common sense to the strategic value the acquisition or exit is to you and your team.
If you are seeking new ways to fund the growth of your SaaS company, talk to us and start the conversation with our finance experts to see whether an Element SaaS Finance loan is right for your business.