Valuing and selling SaaS businesses isn’t straightforward. In fact, in the small business space, valuing SaaS firms is a hot topic of debate and there are different approaches that can be taken. However, if you examine how the most experienced practitioners within the SaaS M&A space operate, you can identify some primary metrics that all sellers need to be aware of if they want to sell their business for the very best price possible.
Below, we look at these metrics in a little more detail. We then talk through who might buy your SaaS business and the acquisition process itself.
How do I value my SaaS business?
Most private businesses are valued based on either a multiple of seller discretionary earnings (SDE) or earnings before interest, taxes, depreciation and amortization (EBITDA). Which of these measures is used for your business will depend on its size.
Generally, if a business has an approximate value of over £2 million or more, a multiple of EBITDA is commonly used as a valuation measure.
Smaller businesses will more often use a multiple of SDE. This is pre-tax, pre-interest profits less any non-discretionary expenses and owner’s benefits and withdrawals.
However it should be noted that for many early stage SaaS businesses, EBIT is not high because of the need to sink up-front investment into growth. So it is not uncommon for other metrics to come into play in a valuation. Below we have outlined some of those that buyers view as most important when looking to acquire a SaaS business.
To gain a premium valuation for your business, aim for sustainable, healthy revenue growth, ideally with a focus on monthly recurring revenues (MRR).. Annual recurring revenue (ARR) is also an important measurement, but MRR is often seen by buyers as the most important, especially where recurring revenues occur more frequently than once a year. The higher the MRR growth rate, the larger the multiple in most cases, although this is also a complex measurement and there can be some exceptions to the rule.
The sustainability, as well as the level, of MRR growth is an important factor. Some businesses have managed to build strong growth but hemorrhage cash in order to get to that position. Ideally, revenue growth and a lean cost base can be achieved, as this will attract the very best valuation for your company.
Most buyers are very interested in the churn rate or attrition rate, as it is also known. This is the percentage of customers who are lost over a specific period of time. It can also be expressed as the probability that a customer will be lost within a specific time period.
If you can achieve negative revenue churn, this is a great metric to have. In fact, new customer acquisition is often viewed by buyers as less important. Negative churn occurs when your additional revenue from existing customers totals more than your lost revenue from existing customers. That means that your recurring revenue is increasing without adding new customer revenues.
SaaS businesses often plough money into new customer acquisition in order to drive up their multiples but that focusing on achieving negative revenue churn is actually more important when it comes to selling a business. According to Totango [link:https://www.slideshare.net/totango/5th-annual-saas-metrics-report] , 55% of SaaS companies rate customer retention cost as the key internal metric to measure.
As well as taking a close look at the financials of your SaaS business, buyers will also be looking at how vital your personal input is on the success of the business. If they find that the business would struggle to succeed if you, as the owner, were not involved, you will have serious problems selling your business.
Taking a step back from the operation in the run up to a sale to demonstrate the autonomy of the business can help you to secure you a better valuation.
Cost of acquisition
The cost of acquisition, or CAC, is the total cost that a business incurs when it signs up a new customer. Those buying SaaS companies take this metric very seriously as, like founder involvement, it gives them an indication of how profitable the firm is likely to be in the future, following a takeover and change of ownership.
Being able to drive down your CAC in preparation for a sale is a worthwhile activity. In addition, if you acquire most of your new business through world-of-mouth, work on demonstrating this, as being able to show a very favourable CAC ratio (period over period increase in gross margin divided by sales & marketing expenses for that period) may help drive up your multiples.
SmartSpace, the UK workspace management software vendor, snapped up a New Zealand-based SaaS company called SwipedOn for around £6m. The annual revenue of SwipedOn was only around £900,000, with its latest filed accounts recording a loss of about £250,000. However what attracted SmartSpace was that SwipedOn's ARR had doubled in the past year, its churn rate was low and it had 2,300 customers in 39 countries.
Frank Beechinor, CEO of SmartSpace, said that the product was very complementary. He added, “We decided on SwipedOn as we felt it met our criteria of offering good value, had a scalable technology, a worldwide customer base, a strong team and established SaaS management processes with the potential for significant growth.”
Who is likely to buy your SaaS business?
Buyers looking to purchase SaaS business have many different reasons for doing so. Brokers claim that working alongside them will help to open up a whole range of potential buyers who most SaaS business owners would have never considered to be buyers. This means that, although you might have some ideas about who would be interested in buying your company, the actual buyer is unlikely to be be known to you, and this is why working with a business broker, or an M&A firm, can help.
In terms of the category of buyer, most buyers tend to have a strategic reasons for wanting to buy your business. Once they have a strategic reason, they will usually be funding the acquisition with cash from their business, their partnerships, their family or individually. Alternatively, they may have input from private equity investors. Some buyers fall into all of these categories.
What does the deal process look like for an SaaS business?
If you want to sell your SaaS business, the first step is often to contact a broker who can help you value your business and attract buyers. Interested parties will work with the broker and hand over information. The broker will then suggest your business to buyers they consider to be suitable.
Buyers will usually have to sign a confidentiality agreement and will be given in-depth information on your business. This will include financial information and often plenty of insights into how the business is run and managed.
Following this, sellers will be invited to ask questions and the broker will also help to organise calls between buyers and sellers if necessary. If the buyer wants to make an offer, this will be the next step, in the form of a letter of intent. More offers are then likely to follow and negotiations on both price and terms will take place.
Once an offer accepted, a due diligence period will begin and contracts will be negotiated and agreed between both parties. Brokers will then usually facilitate the payment and handover process, which can take up to around 90 days to complete.
SaaS businesses are in demand by buyers worldwide and, with a little forethought and by working with the right people, you should be able to find the right acquirer for you. And this doesn't just mean the buyer who offers you the most money, but the buyer with whom you actually build a rapport.
An awareness of the metrics that buyers actually care about when looking to acquire a SaaS business will stand you in good stead to achieve the multiple you hope for. Ensuring you start considering these well in advance of a sale will help you to maximise your valuation and improve the saleability of your business.
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