SaaS (software as a service) is a way to deliver applications and utilities over the Internet. It opens up huge possibilities for business growth. A SaaS company can reach consumers across the world. Users do not have to buy and install any program. Everything operates virtually. Users access the service by paying a subscription fee.
Last year saw lots of merger and acquisition activities. People associated with this industry including advisers, consultants, and entrepreneurs want to know how to value a SaaS business.
SaaS Company Valuation
Lots of factors affect how a company is valued. It is more difficult to value a SaaS business that does not have physical assets like brick and mortar businesses.
Companies with a valuation of less than $10 million are generally valued using EBITDA (earnings before interests, taxes, depreciation, and amortization) factors. This method helps determine the profitability of a company. The valuation also takes into account the balance sheet, assets, IP (intellectual property), and contracts in place.
In some cases, a company is valued by assessing its seller discretionary earnings (SDE) which is the revenue the company owner is left with after accounting for personal and operating expenses. Potential investors and buyers can understand how much cash flow the company needs after accounting for EBITDA or SDE. This valuation method is best suited for valuing small companies. Larger companies have more advanced structures. These companies often use creative accounting techniques to minimize their tax liability.
When valuing highly profitable companies, business valuation methods based on assets, comparable market value, discounted cash flow, ROI, book value, and capitalization of earnings should be used.
The best way to find the true market price of a company is to assess multiple factors associated with it. The investors have to take into account the company’s financial performance, market, niches, operations, customer base, business age, geography, churn, SaaS metrics, growth potential, owner involvement, and CAGR (compound annual growth rate).
SaaS companies with a long track record, limited owner involvement in daily operations, low churn, high customer retention, and lifetime value are highly valuable.
Valuation Metrics
A SaaS company’s churn rate is an important factor when assessing its valuation. A low churn rate indicates better revenue and high growth potential. On the opposite side, the high churn rate indicates the product is not suitable for the needs of the target customers. An annual 3-5% range churn rate is considered normal for a young SaaS company. When the company advances to a midmarket status, this rate should come down to 1-3%.
The company’s customer acquisition cost is another factor when evaluating a SaaS company’s valuation. This cost is calculated based on how much money is spent on sales and marketing to acquire a new customer. A lower number indicates better performance. This factor is assessed in combination with the lifetime value of a customer. This value indicates how much revenue is earned throughout the time a customer is associated with the company and keeps paying for the service.
Other Valuation Considerations
Other factors when valuing a SaaS company are related to the customer acquisition techniques including affiliate, organic, paid, and other channels. A company with more acquisition channels has more stability compared to a company focused on only one channel. The cost involved in converting a visitor or prospect into a customer should be taken into account when calculating the valuation of a SaaS company.
MergersCorp M&A International is a prominent and experienced global advisory firm. It offers professional merger and acquisition advisory services to its global clients that want to buy or sell businesses. Their interests are protected in the deal with its professional support services. This team of M&A advisors, investment bankers, and brokers help companies that have $500,000 – $250 million annual revenues. You can visit MergersCorp.com for further information.
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