I read an interesting article about the core metrics of a business being a better way to measure real value than traditional assets or EBITDA , and thought I’d share some of the components we use to value companies at Scaleworks.
We haven’t quite gotten this down to a science yet, but there is more to SaaS valuations than just revenue x growth (or a multiple of profit if you’re in the normal business world!).
Valuing a business does tend to be an emotional thing, that’s probably one of the reasons M&A bankers exist — to be an unbiased party that level sets founders expectations on reasonable valuations for their business. On the buyer side — I think people always want to be fair but naturally want to do their job well which means getting a price that de-risks the acquisition as quickly as possible (as opposed to paying a very high premium and the requirement becomes out-performance just to break-even on the purchase).
So, here’s some considerations when it comes to buying or selling a SaaS business.
First of all, and most obviously, the top line amount of revenue the company generates matters. At below $2m annually, there just isn’t enough cashflow to staff a team and grow a business, so there is a discount implicit in the ‘hassle-factor’. For most buyers, anything under 10m is an instant non-starter, and even then the universe of buyers really only opens up in the multiple 10’s of millions in revenue. A buyer wants the revenue, and team, to be sizable enough to be stable and relatively self-managing. Smaller companies create a lot more risk.
Segmenting the customer base also matters. If it is predominantly in one small market, and there is concentration in a few large customers — the risk of substitution or shrinkage is high, if something fundamental in the industry changes. A good spread of customers across sectors, locations, industry types, contract sizes and companies sizes is the gold standard.
The most obvious value driver is growth to determine valuation multiples. The pinnacle of this is high growth from a larger revenue base — because it is easier to grow faster from a smaller number, but much harder to keep up this pace as the total revenue grows. A simple rule of thumb is— flat to 20% year on year growth is likely to be a detractor, 20–40% is a solid median for fair-value based on the other metrics, and between 40–60% growth, or more, should yield a valuation increase (the amount will be dependent on your total revenue).
Installed Base Health
The health of a company’s installed customer business is a very important valuation metric. If the existing customer base is happy, churn is under control (sub 2% a month gross cancellations), and the net movement is flat or positive (being — upgrades minus downgrades and churn) this brings a stable customer and revenue base. On the other hand — if the installed base is shrinking, and new customers are needed just to stay flat, this is ultimately a poor end-state for a business, and even with growth, more and more of the new business acquired is needed just to plug the gap and stay flat. NPS is also a great metric to here as a happy customer base is more likely to be a healthy one.
Is the pipeline growing, with healthy conversion rates all the way from visitor to MQL to SQL to Quote to Close? Are customer acquisition costs under control, well managed (and understood)? Is there a provably scalable funnel or set of levers to increase lead flow? If the acquirer can get confidence that there is predictable growth baked into the business, it will help get a deal over the line.
Team and Culture
Put yourself in the shoes of the buyer. How easy is working with this team going to be for a new owner, or within another entity? Is the team excited about the transition and future opportunities? Is the team solid enough to sustain some of the natural churn that occurs in any major change? When the acquirer talks to the executives and key team members — will they walk away happy or feeling like they have their work cut out for them?
A smaller team creates more risk, a lot more risk, which is another reason why most small companies struggle to find buyers. Distributed teams also struggle to find buyers — as the hassle-factor of on boarding people that are not in one place creates a set of unknowns and a lot of additional work.
Is there a super dominant player in your category? Is your business dependent on another platform? Is the space you are in generally growing (and at what pace)? What does the future look like for this sector? How many competitors are there? Where does your business realistically stack up in the competitive landscape and does your market share validate that?
Ultimately, businesses that are winning, in a leadership position, in an emerging or fast growing market, command a premium. If you have ten other competitors with relatively similar products, and the market is well defined (like Project Management), it is going to be hard to get a buyer excited about paying a premium. In fact these things are true — they will result in a discount from base value because of the risk factors undifferentiated businesses bring with them.
What are other public companies in your space trading at? The Techcrunch article that talks about a competitor being acquired for 10 or 20x is irrelevant. They are lottery ticket exits — hopefully with some strategic logic behind them. Instead, look at a comparable public company. It may be growing slower, but a public company is likely also a lot larger in revenue — so it’s a good proxy to sense check against.
You could probably use these levers to come up with a weighted model that gives a ball-park valuation for your company, or one you’d like to acquire. Every company tends to throw up some rule break that doesn’t fit the model — so apply a bit of common sense to the strategic value the acquisition, or exit, is to you and your team.