saas valuation drivers

SAAS VALUATION DRIVERS

Click to edit Master title style xxx One Number Really Matters…

“Simply put, SaaS businesses are traded on a multiple of ANNUALIZED RECURRING REVENUE (ARR). All the other drivers of valuation are tied back to this benchmark in order to support a higher or lower multiple”

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Click to edit Master title style xxx Key Value Drivers of SaaS Companies

Key value drivers every seller should pay attention to as they go about preparing for the sale of their company or their company’s stock.

Other nuances of your business will undoubtedly impact valuation, but theses are the broad-based value drivers.

1. Growth 2. Addressable Market Size

3. Customer Retention

4. Gross Margins

5. Customer Acquisition Costs

http://grve.me/valuedrvers

Click to edit Master title style xxx #1: GROWTH How long will it take to get big and how likely is it to happen?

Historical growth rate is the single biggest driver of valuation. In fact, it dwarfs all other factors. The reason growth is so important is that it indicates both the timing and the likelihood of future profits. Faster growth means larger profits sooner, and because of the recurring revenue model, high historical growth rates are a good indication of future growth rates. There are no public SaaS businesses with growth rates below 20% that have a revenue multiple above 3.5. A 25% level growth rate is a good, bottom of the range, target for emerging private SaaS businesses.


Click to edit Master title style xxx #2: MARKET SIZE How big can your business be?

Because market size has a big impact on valuation, you might want to consider launching into new markets, new geographies, or launching new products before a sale or investment round. Just a few paying customers in the new markets will allow your company to credibly “claim” the expanded market even though it’s not yet fully developed.


Click to edit Master title style xxx #3: RETENTION What is the risk the business might actually shrink and fail?

The total effect of retention is often under appreciated because of its multi-dimensional impact and cumulative nature, which can be modest over a twelve-month planning horizon, but has a large impact over a 3 to 5 year period.

Over 50% of all SaaS companies surveyed reported a retention rate of 90% or better.

http://grve.me/retentionrate

Click to edit Master title style xxx #4: GROSS MARGIN Given your revenue, how much money can you make?

While it’s true net income and EBITDA are not direct valuation drivers for growing SaaS businesses, gross margins are relevant. Gross margins strongly indicate the profitability of your business when it reaches a more mature phase. Gross margins also determine how much revenue your business can channel back into sales, marketing, and product development and therefore, how capital efficient the business will be. SaaS businesses must be able to clearly identify costs associated with professional services versus the costs associated with the product itself. Those two revenue streams are typically valued separately. For SaaS revenue streams, (excluding professional services), gross margins are typically 85% to 95% and a

SaaS business can increase its valuation by intentionally focusing on improving its gross margin.


Click to edit Master title style xxx #5: CUSTOMER ACQUISITON How much money will it take to grow?

High customer acquisition cost (CAC) businesses require more capital to grow and, thereby, diminish overall returns whether the buyer is a VC or a corporation. Your “CAC Ratio” is also relevant to your ultimate valuation because it compares customer acquisition cost to the lifetime value of a customer. The better that ratio, the higher profitability will be over time. A related metric to CAC is the “average length of sale”. Buyers and investors want to understand this metric because it can significantly impact the timing of future cash flows and quarterly earnings.

Short sales cycles also reduce risk because long sales cycle business can be off-track for several quarters or years before an issue becomes apparent.


SALES AND MARKETING

Click to edit Master title style xxx SHOULD you increase sales and marketing spend?

There is a clear connection between revenue growth rate and the revenue multiple applied to a public SaaS companies valuation. SaaS companies growing at 10% to 20% are valued at 2 to 3 times revenue, those that are growing at around 30% are valued at 4 to 8 times revenue, and those with over a 40% growth rate are valued at well over 15 times annual revenue. So given the connection between “spend” and revenue growth, and the clear relationship between revenue growth and value; the answer to the “should you” question for any SaaS business that’s focused on increasing shareholder value is generally “yes”.

One caveat: if your CAC Ratio is negative (customer acquisition cost exceeds the lifetime value of the customer), more sales and marketing spending will only destroy shareholder value sooner.

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Click to edit Master title style xxx CAN you increase sales and marketing spend?

This debate typically comes down to access to capital (think Salesforce.com who “out-raised” and “out-spent” all their early competitors with the majority of funding being spent on sales and marketing). Salesforce is an outlier for sure, but the data clearly show that some type of external capital is required to push growth above 25%. Finding the money inside the company for sales and marketing investment is possible, but it usually means shifting resources away from other investment areas such as product development. This is always an option, but the obvious risk is getting passed-up in the marketplace in product functionality and innovation.

Finding the right source of capital very much depends your business stage and growth plans.

http://grve.me/SandMrkting

Click to edit Master title style xxx Managing Churn

In the haste to acquire new customers and get accounts implemented quickly (to start collecting cash), many early-stage companies pay little attention to existing customers. This might make sense for a year or two, but then the problem of churn really begins to impact the business. By the 5th year of a SaaS company’s life, if not addressed, excessive churn can destroy more than half of a company’s value.

Churn is a good indicator of the health of your SaaS business and ultimately impacts valuation.

http://grve.me/SaaS-churn

Click to edit Master title style xxx Churn Case Study

Retention Inc. and ChurnCo Solutions are providers of B2B SaaS applications who launched their businesses on the same day. They both license their technology on an annual basis and all product features are available to licensed users for a monthly fee. Both companies are booking 10 new customers per month at a flat subscription rate of $1,000 month and spend $120,000 per month on sales and marke4ng for customer acquisi4on (CAC).


Click to edit Master title style xxx Measuring Impact of Churn

Churn impacts four key valuation drivers in the same direction:

REVENUE LEVEL | Growth rate | Profit capacity | Predictability


The cumulative impact of churn grows exponentially as the business matures.



Revenue Level | GROWTH RATE | Profit capacity | Predictability


Somewhat less obvious, but with an even larger impact on value, is the effect of churn on the company’s growth rate: •  high growth SaaS businesses are worth 5 to 8 times annualized revenue

•  slow growth businesses are only worth 2 to 3 times annualized revenue

So while Retention Inc. and ChurnCo have the exact same bookings rate, ChurnCo is growing 35% slower by year 5 than Retention Inc. just because of its higher churn. That difference in growth will have a significant impact on the revenue multiple that prospective buyers will assign to the business.



Revenue Level | Growth Rate | PROFIT CAPACITY | Predictability


The higher profit margin can be re-invested in sales and marketing to further increase growth.



Revenue Level | Growth Rate | Profit Capacity | PREDICTABILITY


The higher the predictability of the future cash flow streams, then the lower the discount rate applied to those cash flow streams and the more they are worth. In the real world, this means a corporate buyer or investor will be much less worried about the business imploding after the purchase and will pay a higher price for that lower risk.

“While there are no databases tracking churn to purchase price, we believe the lower churn business in our model would easily add a 1x increment to the

revenue multiple taking it from 5 to 6”

Click to edit Master title style xxx Valuation Comparison

Because both revenue and multiple are impacted by churn, the change in value is significant.


“In the context of fundraising, the impact can be more profound. We have seen SaaS businesses that fail to retain their customers, for whatever reason, who cannot raise capital at any price. Our own underwriting criteria call for an absolute minimum retention rate of 85%, and the retention threshold for many VC’s is even higher.”

saas valuation drivers

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