by Sam Franklin | September 01, 2022 | 15 min read
How to value a SaaS businessGet funded
Last updated: October 06, 2022
When it comes to selling your SaaS business, you'll need to know how to value it as accurately as possible. There are a couple of different company valuation methods that you can use, and each has its own set of considerations. It's not like buying a widget company where you can look at the cost of materials and labour and determine a price.
Generally speaking, you can sell a business two and four times its annual cash flow. Let's say Company X makes £100k a year. In that case, potential offers may vary from £200k to £400k. Again, this is a generalisation as multiple factors play a determining role in a startup's valuation.
Want to know how to value a SaaS business? This is typically the five-step process involved in valuing a SaaS business:
Understand the types of SaaS valuations
Consider the most important SaaS metrics
Apply the SaaS company valuation equation
Prevent common SaaS valuation mistakes
Increase the enterprise value of your SaaS
A SaaS business must account for future cash flows, customer retention rates, and more. Now, we'll walk you through everything you need to know. Let's dig in.
Table of contents
- Understand the types of SaaS valuations
- Consider the most important SaaS metrics
- Apply the SaaS business valuation equation
- Prevent common SaaS valuation mistakes
- Boost the value of your SaaS business
- Selling your SaaS business
Understand the types of SaaS valuations
There are three main types of SaaS valuations: SDE, EBITDA, and revenue multiple. Each one can give you a particular perspective on the value of a company.
Seller Discretionary Earnings (SDE) is a measure of a company's profitability that excludes the cost of goods sold and operating expenses, not the owner's salary or compensation. This metric gives investors an idea of the company's true earnings power. So if Company X makes £200k a year, has £20k of expenses, and pays the owner an annual salary of £100k, the SDE would be £180k. Any owner's salary/withdrawal/dividends are added to the profits.
EBITDA is short for 'earnings before interest, taxes, depreciation, and amortisation'. It's a financial metric that investors and analysts often use to value SaaS companies with over £5M in value and compare them to competitors within the same industry. It provides a more apples-to-apples comparison than other measures like net income or operating income. As a result, it's a tool for anyone who wants to get a clear picture of a company's financial health.
Revenue multiple is a valuation methodology that uses company metrics and valuation in a similar industry or with a similar business model to estimate another's SaaS business valuation. It's a simple calculation: you multiply a company's total revenue by a multiple. This multiple is determined by analysing comparable SaaS companies, mainly public ones. The advantage of this method is its simplicity. You don't need to build a model or make assumptions about the future. All you need is total revenue, and then you can apply the simplified equation.
Consider the most important SaaS metrics
Which SaaS metrics matter most?
When analysts and investors value a SaaS business, they focus on these five: Customer churn rate, Customer Acquisition Cost (CAC), Customer Lifetime Value (LTV), Monthly Recurring Revenue (MRR), and Annual Recurring Revenue (ARR). These metrics are essential for understanding how much revenue the company is generating, how fast it is growing, and how much each customer is worth to the business.
Churn rate measures the percentage of customers that cancel or don't renew their subscription in a given period of time. A high churn rate indicates that a company is losing customers at a rapid pace, which can be detrimental to its long-term health. On the other hand, a low churn rate shows that customers are happy with the service and are unlikely to cancel their subscriptions. But what is a good or bad churn rate? It depends on the business size and the customer segment you're targeting, but below 10% is okay and below 5% is even better.
Customer Acquisition Cost (CAC), as the name suggests, is a metric that reflects the money a company spends to acquire each new customer. This number can be divided into marketing and sales. Marketing costs include advertising, public relations, and lead generation. Sales costs include salaries, commissions, and other expenses associated with closing a deal.
To calculate CAC, divide the total marketing and sales expenses by the number of new customers acquired. For example, if a company spends £100k on marketing and sales and acquires 1,000 new customers, its CAC would be £100. There are certain scenarios where a business with a CAC of £100 may seem more expensive than one with a CAC of £50. However, if the first business has a higher customer lifetime value (LTV), it may actually be more efficient.
CAC should be considered alongside other metrics such as churn rate and lifetime value because those also impact your enterprise value.
Customer Lifetime Value (LTV) measures the revenue that a customer is expected to generate over the course of their relationship with a company. To calculate LTV, divide total revenue by the number of customers.
If a company has £100k in total revenue and 100 customers, its LTV would be £1k. As a rule of thumb, SaaS businesses should aim for an LTV 3-5 times greater than their customer acquisition costs (CAC). This ratio indicates that the company is generating enough revenue to cover costs and still generate a healthy profit.
Monthly Recurring Revenue (MRR) is a measure of the recurring revenue that a company makes every month. And it's also one of the main factors investors will look at when considering whether or not to buy your SaaS company. This metric is often used to assess the health of a SaaS business and predict future earnings in a more reliable way. Most of the time, a company with a strong monthly revenue growth rate is seen as being more valuable.
Annual Recurring Revenue (ARR) measures the amount of money that a company can expect to earn on a yearly basis from its recurring revenue streams. The higher a company's ARR, the more valuable it's likely to be since it's a good sign for future growth. On the other hand, a low ARR denotes that the company isn't generating enough to sustain growth. Several factors affect a company's ARR, such as pricing strategy, churn rate, the size of a customer base, etc.
Apply the SaaS business valuation equation
For instance, imagine you own a streaming platform called Popcorn. This subscription-based video service has £10M annual revenue. You want to know the company valuation but must figure out the multiple revenue numbers first. So what do you do?
List already established streaming platforms similar to yours with their business revenue and valuation. Both metrics are relatively easy to find on Google by typing 'company name + revenue' or 'company name + market capitalisation'.
Then, do the following math [valuation ÷ revenue] to get the revenue multiple.
Busterflix: £25M revenue, £50M valuation = 2.0x ← revenue multiple.
Walt+: £40M revenue, £60M valuation = 1.5x ← revenue multiple.
Congo Prime: £30M revenue, £90M valuation = 3.0x ← revenue multiple.
Finally, calculate the average revenue multiple. In this case, it's 2.1x. This last number is the one we'll multiply by Popcorn's revenue, which is £10M, which would end up being 2.1 times £10M, resulting in ~£21M. Ta-da! That's your estimated SaaS company valuation.
Revenue multiple formula: Valuation = ARR x Revenue Multiple
Although the revenue multiple is a fairly simple calculation, it provides insights into a ballpark estimate of a company's worth – if it's undervalued or overvalued. When doing SaaS valuation, use conservative assumptions and give yourself a 15% margin of error.
Alternative: Explore SaaS valuation calculators
The SaaS industry has undergone a major transformation in recent years. As the market has matured, a new wave of startups has entered the scene, eager to capitalise on the growing demand for solutions of all kinds. This has led to a more competitive landscape and a greater need for accurate valuation tools. A SaaS company valuation calculator can help you determine the worth of your company by taking into account a variety of factors, such as:
Industry and risk
Assets and liabilities
Profits and losses
And so on...
Whichever calculator you choose, ensure you understand how it works and what assumptions it makes (read the disclaimers). This will help you interpret the results and make the best decisions for your business.
Here are three of the best SaaS valuation calculators:
This calculator uses several factors to come up with a valuation, including annual earnings, the anticipated rate of earnings/compensation growth, level of business/industry/financial risk, excess compensation, expected years of earnings, and discount for lack of marketability. You can input all of this, and the calculator will give you an idea of your company's worth.
The EquityNet calculator is a great place to start when looking for SaaS valuation. This tool considers various components: industry and risks, assets and liabilities, and profits and losses. Plugging in your numbers will give you a high-level overview of your company's value. Remember that this should be used as a starting point for further analysis. Working with a qualified business appraiser can help you better understand your company's worth.
If you want to dig deeper, with just a couple of inputs here and there, you can get a detailed report that considers sales revenue, net profit, fixed assets, working capital, non-operating assets, borrowing, seller's discretionary expenditure, cost of equity, and settings. While ExitAdviser may not be suitable for all situations, it's good if you want an easy alternative that can give you a sense of the potential value of your SaaS business.
Prevent common SaaS valuation mistakes
Some startups fall into the trap of overvaluing their SaaS business and end up either selling too early or waiting too long to go public. In order to maximise enterprise value, be aware of these misconceptions.
Doing a valuation based on the general market
Every SaaS business is different, and the general market is made up of tons of SaaS companies, many of which are not in the same industry as your startup. So relying too heavily on the general market can lead to an inaccurate valuation. A better approach is to base your valuation on the specific yet comparable sub-market/market that your business operates in.
Strictly comparing your SaaS with competitors who just sold
While it's important to understand how your company stacks up against the competition, this shouldn't be the only reason considered. Instead, it would be best if you also looked at your company's unique strengths, future growth potential, financial performance, and more. For example, say your SaaS company has a highly efficient sales process and retains customers for longer. In that case, this could be worth more than any pros a competitor might have.
Thinking your business is 100% on par with public companies
One of the most common mistakes when valuing a SaaS business is blindly comparing it to publicly traded companies alone, leading to a not-so-accurate startup valuation. They tend to be more established—with longer track records and more predictable revenue streams, less risky, have higher valuations, and don't grow at the same pace as SaaS businesses.
This is often done because public companies are the only businesses that have disclosed their financials and can be easily researched. That's why we talked about the 15% margin error before. So, don't think you should value your business at the exact same multiple as a public company. Instead, focus on balancing your SaaS metrics with the use of publicly-traded companies' information with the simplified formula to land on a number that makes sense.
Boost the value of your SaaS business
Do these things and increase the chances of adding value to your company and, therefore, make your offering more attractive to potential buyers or investors.
Reduce the churn rate
Churn. It's the bane of every SaaS company's existence. High churn rates can quickly eat away at your customer base and make it challenging to generate new leads. It's a major problem for SaaS businesses because it can eat into profits and impede or block growth. An effective way to reduce your churn is by improving customer satisfaction. How?
Providing better customer support
Offering more (useful) features and value for the price
Making it easy for customers to use your product
Giving users/customers a free trial period
Discount longer-term subscriptions
Learn what churn is, how to calculate and reduce it. All here: SaaS metrics 101.
Outsource support and development
By partnering with a development team, you'll be able to focus on what you do best - developing your product and growing your business. And by outsourcing your support, you'll also free up time and resources that can be better spent on other business areas. In short, outsourcing is a smart way to boost your SaaS business revenue multiple, something between 0.5x – 0.75x. This will allow you to reinvest in your business and scale at a faster pace.
Protect intellectual property (IP)
Another important thing you can do to increase your SaaS business's value is secure your intellectual property. This includes things like your source code, algorithms, and other unique aspects of your software. This way, you significantly reduce the probability of others copying your software and competing with you in the marketplace. And what's more, you can also use your intellectual property (IP) to licence and produce revenue from other companies.
Register whatever you need at the UK Intellectual Property Office (IPO).
Document the source code
Code documentation is essential for understanding the inner workings of the software behind your business as it gives potential buyers a clear image of your technical architecture, especially in deals of £500k and beyond. It gives them greater confidence in the long-term prospects of your SaaS company.
Here's a Berkeley Library resource you might find useful: How to Write a Good Documentation. This guide includes tips on what to include in your documentation and why, best practices, how to format and structure your docs, and tools for documentation.
Improve product positioning
By this stage, you have a product that solves a problem for your target market. You've also built up some early adopters and are beginning to generate word-of-mouth buzz. Now it's time to start positioning your product in the market. This means creating a unique selling proposition that sets your product apart from the crowd.
Even if you're planning to sell your SaaS soon, having a strategy in place will increase your company's value. This is because it brings some extra money to you, lifts the earnings figure (SDE), and creates positive customer feedback and PR, meaning you can directly impact how much your business is worth.
Selling your SaaS business
Your SaaS business is your baby. You've poured your blood, sweat, and tears into it for years, and now it's time to cash out. But how do you go about selling your SaaS business? There's a lot to think about: What's the right time? Who's the right buyer? How do you get the best price? But once you've decided to sell, there's one more important question: how?
Marketplaces offer a ready-made pool of buyers interested in acquiring SaaS companies, a streamlined sales process, and a built-in community of buyers and sellers. And because there's already demand, you're likely to get offers relatively faster for your offering. Although you'll have less control over the sale process and may have to accept a lower price than you would if you negotiate directly with a buyer, transactions can be completed in 6–9 months.
An auction is a process where potential buyers submit sealed bids, and the highest bidder wins. This type of sale is commonly used for businesses valued under £5k and when multiple buyers are interested in the same company. It's an interesting alternative to selling because you get fair prices for your business, allowing you to close the deal in a matter of weeks.
A broker is a middleman who helps to facilitate the sale of a business by connecting buyers and sellers, negotiating the sale price, and managing the overall process. While this involves commission fees ranging from 10% to 15%, it can be a helpful way to sell your company. Brokers have access to a broader pool of potential buyers. They can help you get the best possible price for your company and manage the entire sale process from start to finish.
One option is to go the direct route and find a buyer yourself. This is a time-consuming process due to the cold outreach you may need to do. It can take anywhere from 3 to 24 months. Still, you'll have more control over the terms of the sale and negotiate directly with the buyer, which could save you intermediary costs and lead to a higher sale price.
So, how do you value SaaS businesses? You can use the multiple revenue equation we've outlined above to come up with an approximate number. However, it's important to remember that numerous key factors go into a final SaaS valuation, so this should only be used as a general guideline. As you continue to grow your company, make sure you track all of the key metrics: churn rate, customer acquisition cost (CAC), customer lifetime value (LTV), monthly recurring revenue (MRR), and annual recurring revenue (ARR).
If you can maintain sustainable business growth, you'll be well on your way to dramatically increasing the value of your startup.
If you are still working to scale your SaaS business or need extra capital for new initiatives, you can apply for up to £10M of revenue-based funding with Bloom.
Sam founded his first startup back in 2010 and has since been building startups in the Content Marketing, SEO, eCommerce and SaaS verticals. Sam is a generalist with deep knowledge of lead generation and scaling acquisition and sales.