SaaS Website Valuation
Software-as-a-Service businesses are a different beast compared to most other online business models. SaaS businesses have completely different key performance metrics and can be valued off a number of unusual metrics. While a normal online business sells for a multiple of its earnings, SaaS businesses commonly sell based on a multiple of their revenue, or their annual recurring revenue.
With that being said, if we analyze the marketplace for all online/digital SaaS deals and calculate their earnings multiples, they usually sell for 2.5x-5.0x earnings (either SDE or EBITDA).
This is the widest range you’ll see for any online business model. But that’s because SaaS business models can vary drastically, and growth trends and further growth opportunities are significantly more important. SaaS businesses will sell for the highest multiples because of their high growth levels, and recurring revenue, which has a compounding effect on growth.
Top 5 Value Drivers for SaaS Businesses
- Churn rates
- Customer LTV and acquisition costs
- Monthly and annual recurring revenue
- Age and growth trends
- Owner involvement and outsourcing
1. Churn rates
Churn is one of the most important drivers of value for SaaS businesses as it impacts growth, cash flow, LTV, and numerous other metrics. High customer churn rates crush long-term growth and deteriorate customer lifetime value.
Additionally, high churn rates could suggest that the business doesn’t offer a great product, that there are stronger competitors, or that there is limited long-term opportunity for the product in the market.
What levels of customer churn are acceptable? There isn’t a specific answer to this one. Large SaaS companies typically have sub-10% churn rates, but these rates increase significantly for smaller and mid-size SaaS companies, usually in the 20-30% annual churn range. Ultimately, it depends on the customer base you are targeting, and the product you are offering, but most online business investors will be looking for annual churn somewhere in the 20% or lower ballpark for the highest multiple businesses.
2. Customer LTV and acquisition costs
Lifetime value (LTV) is the amount of revenue that the average customer generates over the lifetime of their subscription. Customer acquisition cost, also commonly referred to as CAC, is the marketing and overhead costs required to acquire a new customer.
Obviously, a high LTV and low CAC is the best combination. But, having a high LTV is important because it means that the business is able to spend more money on marketing to acquire one customer. Both of these numbers are going to vary drastically depending on the business, so there is no magic number.
However, we can compare the two numbers side by side. Generally, investors are looking for the CAC to be approx. 25% of LTV, or lower.
3. Recurring revenue
SaaS businesses achieve the highest valuation multiples because the revenue is recurring.
When it comes to recurring revenue, monthly recurring revenue (MRR) is the top dog, followed by annual recurring revenue (ARR). Lifetime subscriptions are going to hurt valuation because there is no additional benefit the new owner is going to receive from them, but they will be burdened by continuing to support the customer.
Additionally, having a high number of annual recurring clients is going to reduce valuation. This is because annual subscriptions tend to have higher churn rates – and the cash flow cycle is way longer. Investors pay for cashflow. If your SaaS business has a ton of annual subscriptions, the investor might have to wait 11 months to generate the cash flow that he paid upfront for when he bought your business.
4. Age and growth trends
While I tend to say that the 2-year mark is an important milestone for online business valuation, SaaS investors usually like to see more history. For the highest multiples, SaaS businesses should have at least 3 years of operating history.
The reason SaaS businesses need more history is that their data and key business metrics are significantly more important. A 1.5yr old SaaS business probably doesn’t have enough data history to prove churn rates, LTV, CAC, etc., especially if the business took a year to get off the ground.
Sustainable growth is important, and therefore, you need more history to show that growth is consistent, stable, and sustainable. Huge growth rates only help multiples when the huge growth has shown to be consistent and can provide the investor comfort that it will continue to be sustainable.
Upward trends in customer base and MRR are important. Selling a SaaS business that is churning customers faster than it is growing is very difficult, and risky for a buyer which will result in a lower valuation.
5. Owner involvement and outsourcing
SaaS businesses are built on software that needs to be continually updated, improved, and supported. Investors are looking for businesses that are already utilizing outsourced labor for customer support, software maintenance, etc.
While there are investors out there that might have some programming experience, if you are the primary software programmer, you’re going to take a valuation hit. Otherwise, the new buyer will need to find an individual to outsource this to, which costs money, and there is risk in finding the right person.
There was a SaaS business I saw awhile back that I really liked – it offered algorithmic trading robots for stock trading. But, it was a $1mm business and the owner was the sole employee. Because nothing was outsourced, and he had no idea how to find someone to outsource this work to, his buyer base was limited to people who already knew how to build algorithmic trading robots. How many people do you think: (1) know how to build trading robots, and (2) have experience running a SaaS business, and (3) want to buy this business, and (4) have $1mm of liquid capital to purchase it? The answer is maybe a handful, and the seller certainly didn’t find one of the handful.