When we talk about valuation, every company model has its own set of difficulties. The SaaS Business model, which has been around for a long time now, is steadily gaining popularity among many businesses. Because of this surge in popularity, people who specialize in business valuations have gained a lot of knowledge about valuing a SaaS company. When it comes time to determine the economic value of a company, the question "how much is my SaaS company worth?" comes to the mind of the owner. For the purpose of creating an appropriate valuation for a SaaS-based company, we'll go over some of the important SaaS valuation metrics you should be familiar with.
Growth of SaaS companies
With its rapid growth, SaaS has become the most elegant form of the software industry, and it is leaving its mark in the corporate world. Whether it is for a startup, a small to medium-sized business (SMB), or an enterprise, software as a service (SaaS) is a developing sector that offers a limitless number of career possibilities.
How do SaaS companies get valued?
The answer to “how to value a SaaS company?” involves many different aspects. There are four main criteria that influence the majority of SaaS valuation estimates. Let's take a closer look at what each of the four indicators is and how they are utilized while valuing a SaaS company.
4 revenue metrics to consider when valuing Saas
If you want to know how to value a Saas company, the first question is if you should look at a multiple of SDE, EBITDA, Revenue, and NPA and understand these four revenue measures.
Seller's discretionary earnings (SDE) is one of the SaaS valuation metrics that is often considered in small to medium-sized companies. A company's worth is mostly determined by the amount of money that the seller has discretionary earnings. In practice, this implies that every seller should be familiar with the formulas used to compute SDE. This will help them make more accurate in-progress evaluations and establish more specific goals when it comes time to put your company on the market for sale.
The pay of the owner is taken into consideration while calculating profits. They provide a more accurate representation of the real profits generated by the business at the time of writing.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a term that is similar to SDE. The owner's pay is retained in this SaaS valuation approach. Still, interest, taxes, depreciation, and amortization are all put back into (or removed from) the business revenue to calculate the company’s value.
This occurs for the same reason that SDE puts expenditures back into the budget. The aim is to normalize the business's revenue so that the manner in which it is funded and the tax decisions it takes are no longer factors in the calculation of the income. Once again, this provides prospective investors with a more comprehensive view of the company’s financial health.
As a result of its accuracy, revenue multiples have risen to become one of the most often used SaaS valuation metrics for measuring tech values. Calculating revenue multiples is as easy as dividing the enterprise value of a business by the amount of revenue it generates. This is helpful because it allows you to quickly get the results of valuing a SaaS business listed on the public market, enabling you to calculate an average revenue multiple for the whole SaaS sector due to your efforts. Non-public software businesses may then be valued using SaaS valuation multiples by multiplying their revenue by the amount determined in the previous step.
Once the valuation of a company has been completed and the connection between revenue and that value has been established, it is possible to estimate how much an unknown value is worth based only on revenue data.
The net present value (NPV) of a financial asset is a method of accounting for the effect of time on the worth of money. It is a method of accounting for what is known as the temporal value of money (TVO). It estimates all of the money that a project or company is anticipated to generate over a certain period, converts that amount into today's dollars, and subtracts the invested amount. A positive number implies that the investment is a good one. The discount rate is the interest rate that was utilized to make the modification.
Other important metrics for SaaS valuation
Investors considering purchasing a SaaS company are looking for areas of strength and difference. Investors frequently look at a few key measures to discover points of strength and differentiation.
Let's take a look at the most often used metrics in SaaS valuation:
The churn rate refers to the proportion of customers who quit their memberships or subscriptions company’s products and services monthly or yearly. A high churn rate indicates that the business must spend more money to replace consumers who have left. It is unsustainable over an extended length of time and results in a poor return on investment. It’s reasonable to expect a monthly churn rate of about 5 percent, but it should be much lower for bigger companies with more consistency. Anything more than 10% is considered a major red sign.
Customer acquisition cost
When it comes to selling products or services, client acquisition costs are the costs associated with acquiring new customers. Client acquisition expenses are often associated with customer lifetime value since they are such a significant unit economy. Any business may use CAC to determine how much money it is spending on each new client it acquires. It's essential to keep this number as low as possible at all times, but it's especially critical when churn rates are high. To determine if a company's CAC is acceptable, we must also know the LTV of its customers.
MRR and ARR
In order to assess the financial health of the company, it is critical to look at both monthly and yearly recurring income. There is no fixed good or poor value for these indicators since they must be evaluated in the context of a company's expenditures. It is true that investors favor monthly recurring income over yearly recurring revenue. This is due to the fact that greater monthly income allows a company to refill its cash reserves more quickly.
It is much more difficult to anticipate how a company will function in the future and its scalability when there is no prior history. In comparison, a company that has shown consistent growth over a long period of time is much simpler to anticipate. Investors can have a good sense of how the company will do if they wait three or more years. The pool of prospective purchasers will be considerably narrower in less than two years.
Business and market trend
The most significant advantage of having a history is that it allows investors to see patterns in the company. A company that has been continuously losing money will be much less appealing than one that has been consistently generating profits year after year. Additionally, patterns in the broader SaaS industry will allow investors to conduct a more realistic SaaS valuation of a specific company. When the market as a whole performs extraordinarily well or exceptionally bad, it helps to put the performance of an individual company into context.
The multiple is one of the most significant components of the equation, and it is influenced by a plethora of variables that are specific to the SaaS industry. It is important to note that although these variables include a broad range of financial, traffic, and operational issues, the ultimate question is whether or not the company will be profitable in the long run. Any operational or market element that has an effect on these issues, either directly or indirectly, may have an impact on the multiples.
Crucial involvement when valuing SaaS
In the early stages of establishing a company, you, as a founder or an owner, are directly engaged in virtually every operation element. The responsibilities of your position include supervising developers (or serving as a developer yourself), executing marketing campaigns, creating conversion-focused content, providing customer support, etc. If you're still indulged in all of those responsibilities when it comes time to sell, you're going to have a major problem on your hands.
Non-technical buyers do not understand the coding expertise that you may possess. In addition, they are seeking to buy an asset that can be financed using leverage. They are less interested in buying a company that is just a job disguised as a profit center.
???????Ideally, you as a founder should try to build up systems, processes, and people in such a manner that your actual participation is limited to a minimum. In many cases, the ideal firm for a buyer is one that they do not have to actively manage since there is personnel in place who understand the company's goal and can carry it out without the buyer's involvement.
Get your SaaS valuation
While the SaaS valuation multiples listed above directly affect the value of a firm, it is always essential to examine possible obstacles to a seamless transfer of a company's assets. It is possible that undocumented code, poor financials, non-transferable agreements, conflicting interests, and continuing legal problems may have consequences that range from a delay to a total derailment of a prospective sale. As a result, the buyer pool and the market demand are reduced. Knowing your statistics is one of the most effective methods to guarantee that your business's presale and sale processes go smoothly.