Software as a service (SaaS) companies are experiencing rapid growth, and the industry generated revenue of over $100 billion in 2020. Businesses are shifting from purchasing and installing software products to the SaaS subscription model. By operating on the cloud, SaaS companies can deliver product updates immediately, which increases business productivity.
If you’re considering a business sale, a SaaS business valuation will have a big impact on the sale price you receive. A business broker can provide a SaaS valuation calculator, and help you with each step of the sale process.
To understand an SaaS valuation, you need to consider the factors that make a SaaS business attractive to buyers.
FACTORS THAT DRIVE BUSINESS VALUE
Your industry knowledge and management experience help you understand what makes your business valuable. However, a business broker may uncover additional factors that will increase the valuation of your company.
GENERATING MONTHLY RECURRING REVENUE
Business owners value a predictable revenue source, and SaaS firms generate monthly recurring revenue (MRR) from subscriptions. If subscription revenue is trending up, your company is more attractive to buyers. The buyer’s goal is to recover the purchase price from sales and profits, and MRR adds a degree of certainty to monthly revenue projections.
EVALUATING CUSTOMER LIFETIME VALUE
Many people shop at the same grocery store or use the same dry cleaners for years, because the business provides great products and services at a fair price. If your software consistently solves a customer problem, you can generate subscription revenue month after month.
Think about the software applications that you use in your business. Salesforce, for example, provides customer relationship management software, and thousands of businesses pay for Salesforce software each month.
Qualtrics defines customer lifetime value (CLV) as “a measurement of how valuable a customer is to your company with an unlimited time span as opposed to just the first purchase.” The longer you can retain a client, the higher CLV you generate, and that figure increases company value.
MINIMIZING CUSTOMER ACQUISITION COSTS AND CHURN RATE
Generating revenue comes with a cost, and customer acquisition cost (CAC) is the cost incurred to acquire a new customer. A high cost to acquire a customer can be justified, if you can retain the business for years.
Every business loses customers over time, and “churn rate” refers to the percentage of customers who continue their subscriptions in a specific period. A low CAC with a low churn rate is ideal, and these factors boost the value of your business.
WELL-DOCUMENTED SOFTWARE CODE
To sell your SaaS business, you must consider the buyer’s ability to use the code that runs your software. The source code must be well documented with annotations and notes that help the buyer’s programmers to operate the software. The code must be tested, so that a buyer can rely on the accuracy of the code.
DIFFERENTIATION THROUGH CUSTOMER SERVICE
As technology improves, users have higher standards for the products and services they use. We’ve all had a bad customer service experience, and stopped doing business with a particular company.
If you deliver great customer service, you can minimize churn rate, and gain business from clients who are dissatisfied with your competitors. Use these best practices:
Make it easy for customers to text, email, or call customer service. The information should be clearly stated on your website.
Maintain a fast response time, and tell the customer how long they will remain on hold when they call.
Keep customers informed as you work on issues, and resolve problems quickly.
Effective customer service is a great way to differentiate your business from the competition.
After discussing these factors, the broker will generate marketing materials to explain the value of your business. A broker can also explain the most common valuation multiples used for a SaaS business.
SAAS VALUATION METRICS
ProfitWell explains that a SaaS business valuation is based on a number of factors, but three metrics are most commonly used: seller’s discretionary earnings (SDE), earnings before interest, taxes, depreciation, and amortization (EBITDA), and revenue.
The seller’s discretionary earnings (SDE) balance assesses company value based on the earnings that an owner generates from the business. Here’s the formula:
(Pre-tax, pre-interest earnings) + (vehicles, travel, other transactions listed as business expenses)
SDE adds back business expenses that have some personal benefit to the owner. In addition to vehicles and company travel, you may add back charitable donations and your company salary. The goal is to calculate the total financial benefit earned by the owner.
The earnings before interest, taxes, depreciation, and amortization (EBITDA) formula is a commonly used metric to value businesses. As the name implies, this method adds back some expenses to the earnings total.
REVENUE VALUATION RANGES
SaaS Capital reports that private SaaS companies are traditionally valued at four to nine times annual recurring revenue (ARR), but that recent 2021 valuations are in the 10 to 12 times ARR range. We:NXT Consulting reports similar valuation ranges.
To be fully prepared for a business sale, you need a broker who understands the valuation metrics for your industry.
HOW RAINCATCHER CAN HELP
The brokers at Raincatcher have helped thousands of business owners sell their companies, and they are experts at valuation. Raincatcher provides several types of business valuations, and you can access a Business Valuation Calculator on their website. Contact Raincatcher to sell your business in less time, and for an attractive sale price.