Software as a Service (SaaS), a way of providing utilities and applications over the Internet, offers the possibility of easy global access to a large network of applications without the need to purchase and install software on a single computer. It allows everyone to access a large network of software and virtual services by paying a fixed price, usually in the form of a monthly fee.
There was a lot of merger and acquisition activity last year, and it continues at a rapid pace this year as well. Many entrepreneurs, consultants, and advisors are asking themselves: how much is a SaaS business worth?
Evaluating a company
Valuing a company depends on a large number of factors and elements. Valuing a SaaS business can be even more difficult, as there are more factors to consider compared to traditional businesses.
Companies valued below $10 million are generally valued using an EBITDA (earnings before interest, taxes, depreciation, and amortization) multiple, which is a measure of a company’s profitability. The balance sheet, asset list, intellectual property (IP), and existing agreements are also taken into consideration.
In some situations, when evaluating a company, advisors and consultants consider SDE (seller discretionary profit), which is equal to the revenue remaining to the business owner after deducting all operating and personnel expenses from gross revenue. An EBITDA or SDE-based valuation helps potential buyers or investors understand the cash flow they will receive from running the business.
This approach can only be applied to small businesses, since in larger public and private organizations the business structure is more sophisticated, especially when there are strategies to optimize and minimize tax liabilities through the use of creative accounting.
Considering small and medium-sized enterprises (SMEs) – companies defined as businesses with a maximum of around 250 employees – we can consider SDE or EBITDA as the best method for valuing a company.
For highly profitable companies, it is useful to use business valuation methods such as comparable market value, asset-based valuation, ROI-based valuation, discounted cash flow (DCF), earnings capitalization, and book value.
For SaaS companies, this can be a significant limitation, given that these companies are generally in the early stages of growth and are reinvesting their revenue back into the business.
As discussed, for small private companies, using a multiple to determine the company’s value is one of the most effective ways to arrive at a market price. This multiple will also be affected (increased or decreased) by a large number of factors depending on: financial performance, operations, product and market, niches, customer base, geography, age of the business, owner involvement; CAGR and growth; buzz; and other SaaS metrics.
According to market analysis over the last 10 years, SaaS companies typically sell for an annual profit margin (EBITDA) of 3.0x to 12.00x, depending on many of the variables discussed above.
A highly valuable SaaS company is one with a long track record where the owner isn’t really involved in day-to-day operations and exhibits a favorable trend with low churn, lifetime value (LTV), and customer retention.
Evaluation metrics
While the general evaluation factors above are an important consideration, it’s important to note that each SaaS company is unique and each has its own priorities in terms of metrics.
Customer churn is an important element to consider when evaluating a SaaS company. Low churn is synonymous with growth and improved revenue. A high churn rate has the opposite effect and can also tell investors that the product does not adequately meet customer needs. According to several studies and research, an acceptable churn rate for a young SaaS model is in the range of 3-5% annually; this range should decrease to 1-3% after the company reaches a mid-market position.
Another key element to consider when evaluating a SaaS model, but also other businesses, is determining the customer acquisition cost (CAC), which is defined as the total marketing and sales cost to acquire an additional customer. The lower this number, the better, as this would mean you would spend less to acquire customers. This element is combined with the customer lifetime value (LTV), identified as the average revenue earned from a customer over the time they pay for the service. The higher the LTV, the more valuable each new customer will be to the business.
other considerations
In addition to SaaS metrics such as CAC and LTV, several other factors need to be considered in the evaluation process.
Additional things to consider when properly evaluating a SaaS company are factors related to the customer acquisition channel (organic, affiliate, paid channel, or other). A company with a large number of acquisition channels is more stable than a company focused on only one channel. Other important elements for the customer acquisition strategy are related to channel competition and the conversion rate and costs involved.
Stefano Endrizzi is the founder of MergersCorp M&A International, a mid-sized mergers and acquisitions consulting firm. He is also a senior investment bank consultant specializing in mergers and acquisitions, a serial entrepreneur, and a management consultant with over 15 years of international experience. You can follow him on LinkedIn or @mergerscorp on Twitter.
Source: https://www.channelfutures.com/best-practices/how-much-is-a-saas-business-worth
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