When valuating an SaaS company, it's important to consider four factors.
Software as a Service, or SaaS, businesses are the way of the future – and the future is now. Essentially, this business model allows owners to provide their product as a monthly service. Think about Netflix, Hulu and Spotify, they’re excellent examples of this business model.
SaaS is so popular, that a 2018 study revealed that 73 percent of all organizations would have most of their business in a SaaS format by 2020. Because of this rapid shift, it’s no surprise that people are jumping on board and trying their hand at the SaaS business model. There’s one burning question at the center of this trend. People want to know how to value a SaaS business when investing or selling. However, the answer to that question is a little more nuanced than you might imagine.
Let’s look at some factors that determine the value of a Software as a Service company.
Out of all of the different factors that go into figuring out how to value a SaaS business, revenue is perhaps the most obvious stat potential buyers and sellers look for in a business.
Software businesses typically have a higher growth rate than other industries, which is what makes them such an attractive investment opportunity. In 2015, the median revenue growth rate was 44 percent for SaaS businesses.
The higher the revenue growth rate, the better. If your business is starting to stagnate, you may need to try a few growth hacks. For example, Zillow is a company that’s known for adapting the growth hacker mindset and is now experimenting with buying and selling physical houses to grow their revenue even more. Keep experimenting and don’t settle for mediocre revenue growth.
Customer growth is the second most common factor buyers and sellers consider when investing or offloading an SaaS. The growth is represented by the number of people using the service over a quarterly period.
A good rule of thumb is you shouldn’t sell or buy a business that isn’t at least a year old. You’re going to want to see the growth so that you can determine the value of the company.
Customer Acquisition Cost
The third factor you should take into consideration when you want to value a SaaS business is the customer acquisition cost. Depending on the business model, you’re going to have to spend money to draw in customers.
You should view the acquisition cost as the amount of money needed to keep advertising up and sustain growth. Examples of advertising include Facebook ads and Google AdWords. If an SaaS business grows organically, the cost of advertising is less, and, therefore, adds more value to the business.
If you’re looking to purchase an SaaS business, take a look at their domain authority and strength of their backlink profile. The higher the domain authority, the better they will be at ranking for words in Google organically without having to spend a lot of money on ads.
The last factor you should take into consideration when you want to value an SaaS business is current market trends. We all know that the market fluctuates, but it’s also a valuable tool used by those looking to make smart decisions when investing in the idea of software as a service.
Market trends allow investors to value a company based on the projections put forward by experts. If a company is “evergreen” and continues to offer something valuable to the consumer, it’s going to be worth more than a company on shaky ground. Investors are far less likely to put all of their eggs in a basket if they feel like the service could fall through the market floor at any given moment.
The bottom line
All four of the previously mentioned pieces of information are crucial when you want to understand how to value an SaaS business. There’s no one piece to the puzzle. You have to put all of these factors together to figure out what a company is worth now and what it will be worth in years to come.
The key to success is simple, and you’re going to need to take risks to score big. Any smart investor will tell you that you’re better off going with a company that’s seeing long-term, consistent growth. On the other hand, you may want to look for “up-and-coming” businesses that have an exceptional growth rate, light marketing and a potential to fill a hole in the market.
Remember, some people will try to sell their SaaS-based business on sentimental value, so you’ll have to take that out of the equation and work with provable, absolute data.
If you’re on the other end, looking to sell, remember that potential buyers are going to look for value via solid data that they can really sink their teeth into.