How SaaS Valuations Work: Multiples, Metrics and MRR
Software as a Service (SaaS) has taken the market by storm.
Entrepreneurs want to build them, buyers want to acquire them, and investors are looking to fund them. Despite all of this, though, there is still a lot of ambiguity when it comes to valuing a SaaS company for sale. When the penultimate moment comes for you to exit your SaaS business in return for a life-changing capital windfall, it can be an arduous task to figure out just what your valuation should be.
But if you’re reading this article, that means you’re up for the challenge.
Let’s begin by looking at how SaaS valuations actually work.
If you’re unfamiliar with SaaS, we recommend reading our online business models series where we explain what a SaaS company is. Simply put, SaaS is a software licensing business model. In the early days of tech, you would have to pay a highly skilled technician to come out to your place of business to install a software application. Technology innovations and the advent of cloud computing has largely made this practice unnecessary. Instead, software companies lease the use of their software on a monthly basis; everything is accessed via the cloud, bypassing the need for a costly installation process..
Some famous examples of SaaS companies are Salesforce and Hubspot, and it could even be argued that Netflix is a business-to-consumer SaaS company. While these companies are mentioned here, this article is not about the unicorns. It is about you, the bootstrapped entrepreneur who has built something amazing and is now considering an exit.
And if that is you, after reading this article, we suggest you schedule a free exit planning call with us.
What Goes Into a SaaS Valuation?
There are many schools of thought when it comes to valuing a SaaS company. Unfortunately, most of them are not a one-size-fits-all scenario. In the greater scheme of things, one method doesn’t always work for all of the online business models.
After all, every business is unique, with its own strengths, weaknesses, and marketplace challenges.
Fortunately, we can demystify this process a bit for you when it comes to your SaaS business.
If you’d like a general overview on how valuations work for an online business, then check out our free Youtube video below:
SaaS Misconceptions: The 3 Most Common Mistakes in Valuation
As you might imagine, in an industry filled with ambiguity, a lot of errors or myths can persist. These are some of the most common ones.
#1 Comparing Yourself to a Competitor that Just Sold
The narrative of your business is the key here. The problem with comparing yourself to a competitor that just made an exit is that you don’t know the full story. You have no idea if that competitor undersold their business if they were talked down during heated negotiations, or—on the opposite end of the spectrum—they just happened to be really GREAT at negotiations.
You also don’t know anything about the buyer’s motivations. Perhaps your competitor sold their company as part of a strategic acquisition, which historically sells for the highest premium since a strategic buyer is willing to pay extra to own that asset. Or maybe something is very wrong with the business, but the buyer is confident that they can fix it and flip it in two years’ time for a lucrative exit themselves.
At the end of the day, you just don’t know all the details. While it can be helpful to find comparable scenarios as a benchmark, it is not the end-all-be-all answer to your SaaS company valuation. Even if you do know some of the intimate details, and maybe even the buyer’s persona, you are still unlikely to have a complete view of what your SaaS is worth given its unique position in the market.
#2 Comparing Yourself to the Public Market
As above, comparables can help guide you but should not be the only source of input you use for guidance. When you look at comparable companies on the public market, it can be even more disheartening when you realize how much higher their valuations are than your own.
Most SaaS companies that have gone public are going to be worth more than private SaaS companies. The reason being that people can “buy-in” anytime they want to that business, and everyone gets the opportunity to purchase stock versus just a select few in the private space.
These SaaS companies are also huge. They’ve gobbled up a dominant amount of market share in their space, and they are well-funded in both capital and talent. In essence, these public market companies are in a different reality compared to most bootstrapped SaaS entrepreneurs. You can use public data to help you find your valuation, but know that the sale of a private SaaS comes with a heavy discount compared to the leviathans on the public market.
As we sell more SaaS businesses on the Empire Flippers marketplace, we will have more data to share about this private discount. Eventually, that data will also appear in our State of the Industry report, which you can download here if you’d like to view an analysis of 700+ online businesses bought and sold over the last 3 years
#3 Using a One-Size-Fits-All Valuation Service
Many valuation firms and services are going to value your business just like any other. The problem with this is that SaaS is decidedly different from other online business models. While there are many overlapping factors, a SaaS company has qualities that are distinctly different from, for example, an e-commerce store or a content business.
In the end, these distinct differences mean SaaS companies receive higher valuation multiples than other online business models. Now, we’re talking about SaaS valuations and we are an M&A broker, so we’re not completely unbiased here, but…
Our valuation tool has been redeveloped with SaaS in mind. We are the only brokers in the industry with a tool that can give you an automated valuation range based on the real sales data of businesses we’ve sold on our marketplace.
Keep in mind, this tool is not yet 100% accurate for SaaS. But as we sell more SaaS businesses, its accuracy will increase because of the industry-leading machine learning processes we’ve built into it.
In a matter of minutes, our valuation tool will give you a price range based on your various business metrics, saving you potentially thousands of dollars hiring someone to do the valuation for you. If you want an even more accurate valuation, then we recommend submitting your SaaS for sale to have our vetting team take a look at your business.
Now that you know the main mistakes people make in deciding the value of a SaaS company, let’s look into what is and isn’t crucial.
What is Crucial?
When you’re building the business, you are involved in almost every aspect of it. You are managing developers (or you are the developer), running marketing campaigns, crafting conversion-focused content, handling customer service, and wearing a litany of other hats.
If you are still wearing all those hats when it comes time to sell though, you’re going to run into a big issue.
Most buyers and investors of SaaS are what are known as non-technical buyers. In other words, they do not have the coding knowledge you may have. Plus, they are looking to acquire an asset that has leverage. They’re less interested in purchasing a business that is really just a job in disguise.
How involved are you in the day-to-day?
Ideally, you should look to set up systems, processes, and people in a way that limits your actual involvement. The ideal business for a buyer is often the one they don’t need to actively run because there are employees in place who understand the vision of the company and can execute without the buyer’s input.
Is your team doing that without your input?
If the answer is yes, it might be time to groom a general manager to start taking over your roles in preparation for an exit.
This is even more important if you are the main or only developer working on the SaaS. If this is the case, then your priority should be to hire and retain talent that understands the underlying code running the business before you go to market. Otherwise, your buyer pool is going to be limited, and you’ll likely get a lower sales price because the business is just less attractive (more on this later).
Growth and Stability: Will It Last?
While you’d probably love to see your business going up and to the right on all the revenue charts, that is not always the case for the buyer.
Investors do want to see positive growth trends, but they also want to know that growth is sustainable. A small SaaS business that is growing at all costs with zero funding for a long runway is a giant risk that many investors and buyers are going to shy away from. The concept of growth everywhere has led many promising software companies to their demise as high-growth is difficult to maintain.
It is important to remember that when you scale revenue, you may also be scaling inefficiencies that can become difficult to fix once they’ve been extrapolated.
A buyer may look at the various growth levers that you have in place. Are they optimized? Are they efficient? Or is there a problem lurking in one of these levers? A problem isn’t a deal killer; in fact, it can often be seen as an opportunity by a buyer. If all the growth levers have issues, though, then you may have your work cut out for you.
Here are the main growth levers a buyer will look at when judging the sustainability of your SaaS business:
- Churn reduction
- Optimized pricing
- Optimized acquisition conversions
- Lead generation
- The various upsells and upgrade opportunities
If you have a solid map outlining all of these functions, how they work, and how efficient they have been, then you’re likely in a good place from a sales perspective.
SEO as a Valuation-Boosting Acquisition Channel
Search engine optimization (SEO) is when your published content ranks high on Google because of high search volume, and it is a powerful acquisition channel. We’re not saying that other acquisition channels, such as paid media, are not important, but we’re pointing out that the value of a SaaS company can benefit in a huge way from SEO.
This traffic source, once you’ve ranked for the target keywords, can drive traffic for months and years to your business absolutely free. Every customer acquired through this channel is likely to be far more profitable than those from any other marketing channel.
A strong SEO presence will also make your business far more defensible against competition. A competitor can’t just run the same paid media campaign as you, nor can a well-funded competitor price you out of the market in a bidding war on Adwords.
If you’re looking to increase the overall gross profit margins of your SaaS business, then growing your SEO footprint is a tried and true strategy. Ultimately, that increase in gross profit margins is going to lead to a higher net profit overall, which will lead to a greater valuation when it is time to sell your SaaS business.
Is it Transferable? Is it Transparent?
All of this information is good to know, but if your business isn’t transferable or is locked down like a black box to prying investors, then you’re never going to get a deal. You’re probably not even going to get a professional valuation.
Transparency requires having all your documentation in order. At a bare minimum, you’ll want to have well-documented code, standard operating procedures, and clean financials that aren’t all over the place (i.e. in your personal bank account). Most of this can be taken care of over a period of a couple of months. Since you have a lot on your plate as a SaaS entrepreneur, especially one looking to exit, we highly recommend hiring a professional bookkeeping service to go through your books in preparation for the sale. It’ll be worth every penny.
The next point is asking if the business can be transferred without issue. Do you have any special agreements with vendors that won’t be passed along? Is there anything preventing you from giving a new owner 100% of the asset?
Who are you using to manage your payment processing? A common mistake we’ve seen is SaaS owners using a service like Paypal. The issue with Paypal is all those subscriptions are non-transferable unless you give up your Paypal account to the new owner. Even then, Paypal has a history of freezing accounts without giving the owner of the account a reasonable amount of time to take out their money. It is better to switch payment processors now and go through all that pain BEFORE you decide to sell.
Trust us: buyers won’t be interested in your SaaS if they know they’ll have to go through all that frustrating work AFTER they’ve paid you a premium sum.
What is Less Crucial?
Multiple Divorced from Age
One interesting aspect of a SaaS valuation is how they can be divorced from age. We have always talked about how age is an important factor when it comes to selling your online business. The older the business is, the more track record it has, and likely the more solid the business will appear from an investor’s perspective.
SaaS companies somewhat depart from this notion.
The reasoning is that a SaaS company can prove its market fit much quicker than other business models. They can start scaling faster, often don’t have as much seasonality as an e-commerce store would have, and the monthly recurring revenue (MRR) provides a track record of performance that investors can rely on to see if the business is a solid acquisition.
Age is still definitely a factor, it just matters less than in other online business models.
If you want an investor to look at the business, it is more important that you focus on month-over-month growth rather than letting the software age .
Average Revenue Per User (ARPU) is Not Critical
On the surface, ARPU may sound incredibly important to a buyer. It could be seen as similar to an investor looking at an e-commerce store and wanting to see revenue broken down by individual products in the catalog.
The difference is that seeing the revenue per product in an e-commerce store shows you its real performance and gives you some insight into whether you should kill or scale a product; in the SaaS model, the ARPU generally won’t tell you anything meaningful. If you decide to compare your ARPU with another company’s ARPU, the metric becomes fairly meaningless as a way of judging performance.
The problem becomes even more complex when you factor in the radically different ARPUs that can appear between low-ticket, self-serve SaaS products and the high-ticket, enterprise sales-driven SaaS products on the marketplace. The latter is going to have a wildly larger ARPU than the former, but that doesn’t tell us much in terms of the actual value of the company.
Now that we’ve laid some groundwork on what is to be expected and debunked some of the myths, let’s move into the actual valuation.
How Much is a SaaS Company Worth?
There are quite a few ways to value a SaaS company, and almost no consensus on which is the right way. We’ll mainly focus here on privately owned, bootstrapped SaaS companies, as that is what we sell on our marketplace.
SDE vs. EBITDA vs. Revenue
There are three ways to look at SaaS valuations, and they are based on how you look at the actual earnings of the company.
The first is Seller Discretionary Earnings (SDE). SDE is what is left after the owner has paid all expenses, such as payroll, software expenses etc., and have added back their own salary to the business to showcase the business’s earning powers. For the vast majority of the businesses you’ll see on our marketplace, SDE makes the most sense. The majority of the entrepreneurs out there are sole owner operators, with little to no one on their team except maybe a virtual assistant or two. Businesses under $5 million in annual revenue are almost always priced using an SDE model.
The valuation model becomes a bit more complicated if you’ve grown a more significant business that hits numbers higher than $5 million in annual revenue. Usually, these businesses have developed thought leadership within the organization. There are clear department heads and a small staff underneath each of those heads. Often, there are more stakeholders in an operation like this than in a sole operator business, and thus an EBITDA model makes more sense.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. This is a more formal valuation method that takes into account many factors to come up with a market-going valuation for a more complicated, mature business. While similar to the more informal SDE, using an EBITDA valuation method tends to reflect a business’s earning power more accurately at the $5 million and up annual revenue range.
Almost 100% of all businesses bought and sold will use one of these two methods.
Yet, this is where the unique business model of a SaaS throws a bit of a wrinkle into the mix, adding a third type of revenue valuation.
A pure revenue-based valuation is based on growth rate. As mentioned earlier, SaaS businesses can prove their market fit and lasting power much quicker than other business models, thanks to the ever-lucrative MRR. The MRR growth month over month, year over year can be used to forecast future revenue growth. This is a big reason why you’ve heard that many companies that seem like absolute behemoths in the SaaS space are making either no money or actively losing money despite their sky-high valuations.
The reasoning comes back to lifetime value (LTV) and cost of acquisition (CAC) combined with churn or the rate of customers leaving the product. At the start of its growth trend, a SaaS company might be pulling in tons of revenue while burning through cash, realizing that its churn is low enough that it will realize a huge swathe of profits on the longtail.
Now, we’re not saying most SaaS businesses are valued this way; most SaaS businesses never reach the necessary $5 million in annual recurring revenue (ARR). In order to get a revenue multiple-based valuation like this, you’ll need a few things going for you:
- An ARR greater than $2 million
- Strong growth indicators of 50% growth year-over-year
- Founder involvement is not critical.
If your company has these qualities, you stand a shot at getting a revenue-based valuation. Otherwise, you will most likely be using an SDE valuation method. There is nothing inherently wrong with an SDE valuation: you’re likely to get a lower multiple with this method than with the revenue method, but you’re also likely to get a much higher multiple anyways simply because you are a SaaS business with recurring revenue.
For the most part, every other business model starts at 0% in revenue when a new month begins.
Thus, in the majority of cases, you will be rewarded with a higher valuation than that of e-commerce and content site sellers. The recurring nature of your business will also attract many buyers with large liquidity that can pay you for what you’ve built. Overall, whether you end up using SDE, EBITDA, or a revenue valuation model, you’re in a great position to make a life-changing exit.
What is the Multiple?
We’ve talked a lot about valuation methods and what is crucial and non-crucial, but we haven’t talked much about the actual multiple side of the equation.
In a business valuation, the basic formula for figuring out a fair asking price looks like this:
The first part of that equation is fairly easy to get. It is the second part that is shrouded in mystery. Multiples can have wild ranges, from a 20x monthly net profit all the way up to 80x+. It makes sense when you take into account how different each business is from one and another, even if they’re operating in the same business model or even within the same niche!
One of the most important parts to understanding how your SaaS company is going to be valued and ultimately sell for, is to know what actually goes into creating that multiple part of the equation.
A lot goes into finding the elusive multiple for your SaaS business, perhaps more than this article can really dive into. Here are just a few considerations:
Influence Factors on a SaaS Multiple
- Owner Involvement: We mentioned this before, but it is worth mentioning again. Just how involved are you with the enterprise? The more involved you are, the harder it is going to be for you to sell the business.
- Growth Trends: Is the business trending upwards? Some investors might still buy your SaaS if it is declining, but the majority want to see stable growth trends (not hyper growth trends, which could be a red flag for unsustainable growth).
- Age of the Business: SaaS can prove market fit quicker than other business models, making age not as important as it might be otherwise. Still, a longer track record of profitability is going to help you get a better multiple for your business.
- Churn, LTV, CAC: These are 3 of the most important SaaS metrics, which we’ll describe in more depth below.
- MRR vs ARR: We’ll describe this in-depth below as well, but the TLDR is that MRR is more important than ARR when it comes to your SaaS valuation.
Now, let’s cover some of the most important elements that can amplify your multiple and help you sell your SaaS business for a larger premium.
The Key SaaS Metrics Valuation Drivers
Churn is a metric in the SaaS world that measures how long it takes before a customer discontinues using your software. The churn rate is typically calculated at an annual level, taking in the percentage of customers that canceled their subscription versus those that remain paying customers.
Churn is perhaps one of the most important metrics in the world of SaaS. It is how you can forecast your revenue month-over-month, and it helps you understand just how long of a runway you truly have with the business if all acquisition completely stopped.
How Much Churn?
Churn can range wildly from SaaS to SaaS. If a SaaS is more of a self-serve style product marketed towards small businesses, it is likely the churn will be higher than that of a SaaS business that is marketed to enterprise-level corporations and requires a highly skilled salesperson and onboarding team to help that enterprise use the SaaS.
While a VC-backed SaaS targeting those enterprise customers might experience 5–7% churn rates, a SaaS business targeting small businesses might be looking at 30-70% churn in a single year.
Obviously, that is a gigantic range.
A general rule of thumb is that if your SaaS business is targeting small businesses with a more self-serve, low-ticket monthly recurring cost, then you’re likely going to experience a higher churn rate. This is even more true if your SaaS is a seasonal-style product, such as in the recruiting space.
If you’re experiencing a churn higher than 60% annually, then you may have a problem that needs to be fixed. It is ideal to have less than 30% annual churn, but it is generally accepted that 60% is the upper end of normal for the self-serve style SaaS.
On the other hand, if you’re targeting more enterprise-level clients, then you don’t want to be anywhere close to those numbers. In this segment of the SaaS world, you should be tracking an annual churn of 10% or less. At this level, it is possible to still be considered healthy even with an annual churn as high as 30% , but it is not ideal. Most investors will want to see 10% or lower when your SaaS is targeting high ticket sales.
While churn and revenue retention is important, it is not a metric that is valued in a vacuum when it comes to your SaaS valuation.
For most small SaaS business owners, while it is important to reduce churn (which we’ll talk about later), the focus should be on customer acquisition.
2) Customer Acquisition Cost (CAC) and Lifetime Value (LTV)
The next two most important metrics in SaaS are customer acquisition cost (CAC) and their lifetime value (LTV).
CAC is simply the cost of marketing required to generate a single new customer. The lower your CAC, the easier it is for you to grow. On the other hand, LTV is the amount of money you can expect to get on average from every new customer that signs up for your SaaS product. Your CAC needs to be low enough and your LTV high enough that it can beat out your churn to sustain the business for the long-haul.
The LTV/CAC Ratio
As with most of the metrics mentioned in this article, looking at just LTV or just CAC to get a valuation won’t be as helpful as you might think. Instead, you need to combine these metrics and compare and contrast them to get a more realistic picture of how your business is performing.
To compare these two metrics, take your LTV and divide it by your CAC. This exercise lets you make sure that your SaaS is profitable while taking into account your expenses.
Ideally, the LTV divided by the CAC should be at least a 3. Scoring a 3 on this ratio means that your SaaS business is probably healthy in terms of growth and the actual revenue being generated by that growth. This score also provides a cushion in case the company’s LTV goes down or its CAC goes up, which means your SaaS can continue to grow even in the face of hardship.
3) Monthly Recurring Revenue (MRR) vs. Annual Recurring Revenue (ARR)
Just as there are multiple ways of doing a valuation for a SaaS, there are multiple ways to look at the actual revenue being generated. Most of the time, your SaaS will be ultimately valued on net profit rather than revenue, but it is still important to take revenue into account.
Some SaaS owners that want to sell their business may think it is worth their while to offer annual plans and aggressively promote those plans. The idea makes sense on the surface: promote an annual plan, get a huge amount of cash flow upfront, increase your net profit, and make the business more valuable when it comes to the valuation phase, right?
Well… not exactly.
While ARR can be great when you’re looking to build your runway, it is not so great when it comes to actually selling your SaaS business. Investors prefer to see strong MRR over ARR. In their eyes, ARR isn’t nearly as predictable as MRR.
To increase the likelihood of a premium valuation of your SaaS business when you sell it, then focus on increasing MRR over ARR.
Valuing a SaaS Business Using the “Other” Valuation Factors
We’ve covered the primary valuation drivers for SaaS companies. Now, let’s take a quick look at a few other factors that are important but are often not talked about when it comes to actually getting a valuation done.
1) Competition: Who is Already Out There? Who Might Be Coming?
You may be operating in a blue ocean scenario—which means you have no real competition because you’re the category creator. This is rare, though, and it is even more rare that a blue ocean situation lends itself to a highly profitable business. It is more common that the situation is a blue ocean because the market isn’t demanding for a category to be filled; rather, you have come up with something so unique that people want it.
It is more likely you’re operating with competitors in the space. Sometimes, those competitors can be incredibly fierce.
Investors will want to scope out the landscape when looking to acquire your SaaS. How do you stand out? How do you compare? Are there a slew of VC-backed competitors that can simply outplay you in the marketing department? Will those competitors drive up your CAC, at a loss for themselves, just to put you out of business?
All of this is considered by a potential buyer.
If your business is prepared to scale and has a solid defense around it that competitors find difficult to copy (such as a large SEO play or trademarked intellectual property related to your technology), then you’ll find yourself in a much better position to be acquired.
Well-funded competitors are a real concern, considering their deep pockets mean they can ship new features and benefits before you or, as mentioned earlier, simply outspend you to the point where your CAC rises so much that you just can’t survive.
The key question here is… what makes you different? What do you have that the competitors struggle to deliver? That is what buyers will want to know and utilize when they acquire your SaaS business.
2) Product Lifecycle: Stop at a Breathing Point
Every good SaaS business should have a well-documented technical roadmap. This roadmap paints a picture of what is being worked on, what will be worked on, and what is about to come down the pipeline. Ideally, when you go to sell your SaaS business you should be at a point on that roadmap where no major developments are planned.
The business should be handed off as-is to the new owner without the need to launch any major updates. This type of situation gives the buyer the best chance to get their bearings. We recommend holding off on any major update to your SaaS three to six months before you plan on selling the business.
If you are already at the point where new features need to be launched, but you’re also looking to sell the business, then we recommend just not publishing those features to your platform. Instead, have a well-documented battle plan of how you were going to launch it, any marketing that you were planning on doing with the update, and any other collateral ready to hand over to the new owner.
This way you’re giving the new owner a stable business with the bonus of features and marketing angles they can apply when they take over if they choose to.
And yes, as you probably already guessed, having a detailed roadmap of your vision for the SaaS product can be incredibly helpful for a buyer. It gives them a sense of what is possible and outlines a plan for them to get there.
3) Technical Knowledge: Transfer Your Expertise
We’ve mentioned before that you need to remove yourself as a critical component to your SaaS operations. It is especially important that you heed this advice when it comes to how critical you are to the technical aspects of running the business. If you are 100% of the technical talent on the team, that will likely severely limit your actual buyer pool, as most buyers of SaaS are known as non-technical founders, i.e. they don’t know how to code or program the underlying technology.
For many, the technical skillsets can sound like a foreign language or arcane wizardry.
If you want to circumvent this obstacle completely, we recommend having someone on your team that can fulfill this critical position. Even better, have redundancies built-in so that if one person quits, another is there who understands how the code functions.
The technical knowledge aspect is another reason why having solid, detailed code documentation is of utmost importance. The documentation helps the buyer out in a time of need, such as if the technical talent ups and quits on them. Of course, that is only true if the documentation is actually good enough for an outside developer to understand.
If you have not yet started transferring your knowledge, there is no better time than the present.
Of course, you could forego that completely if you’re okay with limiting your buyer pool to focus purely on technical buyers. If you need more help deciding which way to go on this front, and how it might affect your valuation, then set up a free exit planning call with us today.
4) Customer Acquisition Channels: How is the Engine of Growth?
For the vast majority of SaaS businesses, the most important thing to consider is your acquisition channels. These channels are effectively your engines of growth. They drive everything else in the business and, without solid acquisition channels, the business will eventually atrophy and die a slow death (that is, if your churn is decent; if it’s not, it could be a fast death).
An acquisition channel is simply a marketing medium that you are using to acquire new customers, though win-back programs to get old customers signing back up can be an effective route too. Even with a win-back program, you’ll want a clearly defined process.
A few examples of acquisition channels for SaaS are:
- Search engine optimization (SEO)
- Facebook ads
- Linkedin ads
- Content marketing strategies beyond SEO (i.e. collaborations with other brands)
- Affiliate programs
- Outbound sales (we’d only recommend this one for high ticket, enterprise-style SaaS)
- And many more
Since SaaS is typically B2B, you’d want to focus first on all the marketing channels that other B2B companies are using before exploring other mediums. Thankfully, there are more B2B marketing channels today than ever before with the advent of internet marketing. It is extremely unlikely you’ll ever run out of options in terms of where you could do effective marketing.
The real thing to be concerned about is how GOOD you are at that marketing.
If you decide to do five different marketing channels and you’re horrible at them all, you are unlikely to have any streamlined acquisition channels.
Instead, we recommend focusing on a single acquisition channel at first. When you get that process streamlined and producing for you, then it might be time to start exploring a new channel. Keep in mind that with every introduction of a new channel, you will have growing pains. At first, you may lose money on that channel, possibly for a couple of months, before you actually gain enough skill to make that channel work for your specific SaaS.
Once you have these channels up and running, well-documented with standard operating procedures, and delegated to team members or agencies that are doing the work for you, you can start considering how investors and buyers evaluate a SaaS acquisition channel.
Primarily, a savvy investor will want to look at:
- CAC by acquisition channel
We talk about traffic diversification all the time at Empire Flippers. Buyers across all business models, not just SaaS, want to see that the business has a multi-prong traffic approach. When a business relies on a single traffic source, that traffic source becomes a point of critical failure. The moment something goes awry in that channel, the business feels it.
The majority of businesses we sell tend to be driven by a single traffic source. The reasoning for this is that most businesses being sold on our marketplace are run by a sole operator wearing all the hats in the business, from marketing to operations. The sole operator is limited by time, capital and expertise, hence they often are focused on just a single traffic source or primary revenue driver to begin with.
If you’d like to set your SaaS apart, then look to diversify your traffic sources to help get yourself a premium valuation.
The more diversified your traffic portfolio, the more stable your business will be. Plus, it proves that there truly is a market fit and that you haven’t just been gaming a loophole you’ve discovered on a single marketing channel.
In general, a SaaS company is best served by having both an organic content marketing channel and a paid media play. The content marketing channel will always produce the highest ROI, as it is often effectively free traffic once the work is done, but the paid media will help you get to the MRR you need to keep the lights on while your content marketing is bubbling to the top.
Keep in mind, diversity can get you a premium but only if that diversity is actually leading you to profit.
It is better to focus on one channel and master it before adding another to your marketing mix.
Saturation is a common reason given for not purchasing a SaaS or, for that matter, doing anything in the business world. More often than not, this excuse is folly in the making. Every day there are small, bootstrapped, and wildly profitable businesses being developed in the most competitive, lucrative niches out there.
Still, that doesn’t mean a buyer shouldn’t look at the acquisition channel saturation.
If a buyer is looking to purchase your SaaS business and they see your competitors have incredible backlink profiles, then they’re going to know that organic SEO might initially be very difficult to pull off. Likewise, if they see well-funded competitors in the Facebook ads channel, then there can be a legitimate concern that the costs of those ads could likely rise as the competitors try to outbid and outspend you.
No channel is totally bereft of competition and even a small bootstrapped company can compete against the VC-backed competitors. The key is being able to show how you are doing that or the plans you have for future competition.
Show your prospective buyer that your traffic channels are not only working but are also defensible against any newcomers, even if those newcomers are well-funded.
CAC By Acquisition Channel
This is where the rubber meets the road.
You need to be able to show that these channels are profitable, which is where your CAC metric comes in handy. Unlike the total CAC of your company, this CAC metric should be broken down by the acquisition channel.
Within that broken-down metric, you will actually have three metrics to look at for each channel depending on if you offer free trials or not. Those metrics are:
- CAC by free-trial (i.e. how much revenue is generated by the user upgrading after the free trial)
- CAC by paid membership
- Overall CAC by channel, which is a combination of the two metrics above
If you’re not doing a free-trial or freemium business model, then this obviously shrinks to just the overall CAC by acquisition channel.
What investors are looking for here is to see the most profitable engine of growth. It is also worth noting which channels are underperforming, as often that underperformance could be the result of user error rather than an actual issue with the channel. Your Facebook ads might be so costly they produce almost no real meaningful revenue, but a buyer who happens to be an expert at Facebook ads might be able to fix that problem with just a few tweaks.
This goes back to what we mentioned earlier: your mistakes or failures in the business is often an opportunity to the savvy buyer.
If you want to get a premium multiple on your SaaS, then focus on diversifying traffic sources in a way that gives you a unique advantage over your competitors, while tracking the actual CAC breakdown by channel so you can make sure every engine of growth is firing on all cylinders.
8 Ways to Increase the Value of Your SaaS Business
You now know more than 99% of people when it comes to finding out how much your SaaS company is worth. Next, let’s talk about something even more fun:
How to INCREASE the value of your SaaS business to help you create an even more life-changing exit when you go to sell.
1. Protecting Your Intellectual Property
Normally, things such as trademarks don’t give a huge benefit to your valuation. In the SaaS world though, if you have trademarked important technology or have gotten patents for it, that can give you a serious edge over your competitors depending on what that technology is.
The intellectual property from patents, trademarks, or copyrights and even from your brand, all need to be registered in such a way that they can be legally transferred over to the new owner. The process for doing this is relatively straightforward, and most legal counsel can help.
It’s never too late to do this. If your company is several years old and you have not sought any sort of intellectual property protection, there is nothing wrong with going ahead and doing it now. It is far better to do it late rather than never, and to do it before a competitor patents something that you use and ends up hurting your business.
2. Conversion Rate Optimization (CRO)
If your business is getting any kind of significant traffic or even moderate traffic, then CRO should be a weapon in your arsenal. CRO is a marketing tool that allows you to create A/B split testing across your website to see which changes lead to more conversions. The conversion goal could be email subscribers, free trial sign-ups, or actual paid sign-ups to your software.
The beauty of CRO is that you already have done the actual hard work of getting consistent traffic to your website. Ideally, you’re already profitable with this traffic. It is not uncommon to see CRO efforts increase your bottom line by 10–30% in terms of increased conversions, and we’ve seen it as high as 50% with simple CRO changes.
We’re not saying that is what will happen if you do CRO, but it is relatively easy to set up CRO tests across the most important pages on your website to determine what might work better. The time and money spent on CRO is often very small in comparison to the rewards.
You could have several tests set up within a week and, depending on your traffic size, have winners and losers by the end of the month.
If you do a large CRO campaign site-wide six to eight months out from a sale, then you could significantly increase your ultimate valuation because of the increased MRR you’ve created seemingly out of thin air.
3. Testing Price
In a similar vein to CRO, you should be considering testing the price of your software. It is very common that entrepreneurs will actually underprice their software. If what you’ve built is valuable to the end consumer, they will often be willing to pay more.
You can use a similar CRO setup to test pricing until you get statistical significance. Raising your price by even a few percentage points could increase your MRR, and thus your valuation, significantly over time.
It is perhaps one of the easiest ways to increase your valuation on this list and will literally put more money into your pocket.
4. Turn Off Experimental Marketing
In a similar vein to halting the release of major updates to your SaaS, consider killing off all experimental marketing campaigns 6–8 months out before you sell the business. While there is a chance that new marketing may lead to more revenue, there is also a chance it will negatively affect revenue, which will ultimately bring down your valuation.
If you want to test out new ideas, the best time to do that is 16–18 months before you decide to sell the business, so you can make sure it only improves your valuation.
5. Do an Acquisition Channel Audit
This tip may or may not lead to an increased valuation. Remember those numbers you put together that broke down your CAC by acquisition channel? Take a long look at those; if you’re running multiple different traffic channels, you may not be looking closely enough to spot errors, mistakes, or inefficiencies with how you’re running that campaign.
Unlike the other tips above, this tip may cost you some money if you go the route of hiring a few one-off consultants to give you feedback and audit your various marketing expenditures.
Similar to tip #4, make sure you do this well in advance of selling your SaaS. You don’t want to have implemented something a consultant told you to do and have it negatively affect your revenue and, ultimately, your valuation. Instead, implement far enough out to where you can see if the advice was profitable or not.
6. Discounting is a Bad Idea
Some SaaS entrepreneurs think that if they sell a ton of discounted annual plans they’ll be able to inflate their actual valuation. This is simply not true. Buyers are going to discount those annual plans even more in your valuation because annual recurring revenue like this is more unpredictable even in the best of times.
Discounting isn’t a bad idea if you’re looking for explosive growth to really get the word out about your SaaS business, but it is usually the wrong move when you are getting close to exiting the SaaS business.
Remember, buyers want to see healthy MRR; ARR takes somewhat of a back seat.
While annual sales at a discounted rate may not give you the valuation you’re seeking, revenue earned with lifetime deals will be even worse. Often, buyers will look at lifetime deals as an expense since they must continue servicing those clients ad infinitum.
7. Develop a Full Marketing Funnel
Unlike e-commerce stores selling physical goods, a SaaS product can feel a bit more intangible to the end consumer. There are also more factors that go into someone buying a software subscription than in the purchasing in other business models.
All of this means that you need to be able to nurture your traffic into not just qualified leads, but into actual brand ambassadors and evangelists.
One way you can do this is by focusing on your marketing funnel. The majority of SaaS businesses might have a base email marketing drip campaign set up. If you’re wanting to turn your SaaS valuation into the biggest exit opportunity possible for you, then take the marketing funnel a few steps further.
You need to have a developed:
- Top of the funnel
- Middle of the funnel
- Bottom of the funnel
Usually, the top is described as anything that brings awareness of your brand to new people. The middle is the lead magnet, where you get your traffic to opt in to an email list, and the bottom is the email follow up that eventually sells your subscribers on your SaaS.
You can expand upon this simple paradigm by looking at each section of the funnel and giving them each a top, middle, and bottom subsection.
For instance, if you want to expand the middle of the funnel , start with the top subsection being the lead magnet, the middle subsection being the social proof (such as case studies or testimonials), and the bottom subsection being webinar promotions or the downloading of another lead magnet that has more “intimate” knowledge, with the ultimate goal of getting them into the top subsection of the bottom portion of the marketing funnel.
Very few entrepreneurs go through the effort of creating such an in-depth, full marketing funnel but it can lead to a difference of tens of thousands in MRR for you when done correctly, which of course will give you a large lift in your valuation when you’re ready to sell your SaaS.
8. Reduce Churn
And finally, perhaps the most lucrative thing you can do to increase your valuation is to reduce your actual churn rate.
If you reduce your churn rate, then you’re increasing your LTV, which means more can be spent on CAC during growth mode or you can keep more profit and raise your valuation potentially by several magnitudes.
When you’re growing a SaaS business, it is usually better to focus on the LTV/CAC ratio mentioned earlier. This can change when you’re getting closer to actually selling your SaaS business though. As you get into that 8–12 month window before you’re going to exit the SaaS business, take a second look at your churn to see if there is anything you can do to reduce that number.
Two Ways to Reduce Churn
- Onboarding: Have you updated your onboarding process recently? Consider doing video walkthroughs, tool tips, and clearly written FAQs or articles explaining everything the software can do in a way that doesn’t overwhelm but rather inspires those who have signed up to your SaaS business. You can reduce churn if you can get the user to actually use your software on a daily basis, or at least view the software as a required asset for performing whatever task they are doing.
- Customer Support: How fast are you answering tickets? Remember, SaaS is often B2B in nature and that means when someone is stuck or can’t do something, they might not be able to perform their job. The situation can be stressful for that person who has many other things to worry about. The faster you can answer those customer support tickets and the more thorough and nuanced the answers, the better that person is going to feel about the value your SaaS business is offering.
If you really want to reduce churn, consider sending out a survey to all those customers that did churn.
If you’re really serious, give those people an actual call.
Ask them questions and find out what job they were trying to get done and why your SaaS wasn’t doing it for them. This is an investigative process that often leads to some amazing insights. You may discover a bunch of exciting features and benefits you can start offering your customers that will not only reduce churn but also win back a few of those customers you talked to over the phone.
That’s a win-win in our book and a win for your valuation with the MRR you’ve recaptured.
SaaS Valuation and Attractiveness
At the end of the day, it isn’t just the valuation price that is going to help you make a life-changing exit. A more ephemeral, but no less important, aspect of selling your SaaS business is making the asset itself attractive.
You could get a wildly high valuation for your SaaS business, only to be met at the market with the nonreassuring silence in terms of interest in buying the business. The could happen because you didn’t put in the work to make your business an attractive acquisition to a pool of buyers.
Buyers are not looking to buy an expensive job, they’re looking to buy an engine of growth that they can truly leverage. They want an actual investment asset. There are multiple things you can do when preparing a SaaS business for sale that will increase this attractiveness level; while some of them may increase your valuation, that is not the actual goal of doing this work.
The goal is to make the business so attractive that you have a long line of buyers competing with each other for your business. If you do this correctly, you will likely get closer to the full asking price for the business, be able to sell it in record time, and get your choice of the potential buyers that you might enjoy working with post-sale.
Let’s dive into how to make your SaaS more attractive to potential buyers.
Again, documentation comes at the forefront of making your business more attractive. Documenting your code is such an important part of selling a SaaS business that it has been mentioned in almost every section of this SaaS valuation guide.
Next-level documentation is an integral key to making your SaaS business more attractive, especially for the majority of buyers who will not be tech-savvy.
2. Standard Operating Procedures (SOPs)
Similar to code documentation, you need to have a detailed SOP system in place. You can view SOPs as the literal operator’s manual to your business. It may cover everything from how to write a piece of blog content, how to answer certain common questions, or even an SOP about creating SOPs that you found helpful.
SOPs won’t usually add value to your business, but they will add immense attractiveness, which will make it far easier to sell.
3. Outsourcing and Team Building
Many entrepreneurs who want to create a life-changing exit believe that the right move to improve their valuation is to fire their team and do everything themselves. While this does increase the actual net profit of the business, and theoretically the valuation, it actually does a lot of damage.
Remember, buyers want an asset they can leverage. They’re not going to buy your business if it’s just an expensive job in disguise.
You need a solid balancing act between outsourcing roles either in-house or using an agency, and the tasks you’re doing yourself. Ideally, you should be building a team that has some thought leadership within the company and could take over the entire business from you. If you have this figured out, then you’ve put yourself in a very attractive position when it comes time to sell your software.
4. Show Off Your Customer Metrics at Work
We’ve mentioned how important SaaS metrics like churn, LTV and CAC all are but very few SaaS entrepreneurs spend the time to really dial these metrics in. If you have them, then you’re more than 90% of the way to where you need to be.
The next step is presenting them in such a way that the data can be used to make different guesses on what strategies should be pursued or what should be done. If you have a framework of how you’re using these metrics and are collecting them accurately, you’ll give the buyer confidence in acquiring the business.
The metrics give the buyer a roadmap of their own on what to do after the business has exchanged hands; all they have to do to read and interpret the data they are getting from their customers is keep your frameworks alive.
5. If You Buy Now You Also Get…
There is a common marketing strategy in sales letters that are littered across the internet, and it is incredibly effective at converting people on the fence into purchasing customers.
The strategy is the idea of giving the customer a “bonus” if they buy now. Often this comes in the flavor of getting two items for the price of one, or some sort of low cost extra item that makes sense with the bigger purchase.
You can position your SaaS company as having a bonus too, just like these effective sales letters.
In your case, the bonus can be something your company is ready to launch but has held off because you’re selling the company.
Examples of this might be:
- SEO-optimized but unpublished buyer guides
- New features to the software that have not gone live
- New marketing funnels ready to be implemented
- New creatives for paid media not yet launched
- Negotiated deal with vendors at a discounted price that have not yet come into effect
And the list goes on.
If you are running your business as if you weren’t selling it, then you’d probably have a ton of initiatives that you have not yet reaped the rewards of by the time you do actually sell. These initiatives serve as your “bonuses” for the buyer looking to purchase the business.
These can be incredibly effective weapons in your arsenal when it comes to negotiating with a buyer, getting a higher price for the business, and closing the deal much faster than you would’ve without them because the buyer is excited that they already have something they can immediately deploy that could lift up the MRR.
6. Plug and Play
You may have noticed a common trend throughout this entire list.
The majority of these tips all are facets of making your business as “plug and play” as possible. In other words, making the business hands-off for the new owner when it comes to running the day-to-day processes. The more you can do this, the more you set the buyer up to have an automated money-making machine, and the faster you’re going to sell the business and probably at a far higher price than if you had only focused on net profit.
Always think about how you can make the business more passive and take the least amount of time to run. The more you can implement these kinds of changes, the more likely you’ll have an easier time selling your SaaS business.
How Do You Actually Sell the SaaS Business?
You understand what buyers are looking for, how valuation works for your SaaS business, and even what makes it an attractive asset to investors.
Now, it is time to do the actual selling so you can get that life-changing exit and, likely, one of the largest capital windfalls you’ve ever experienced.
There are many different routes you can go to sell a SaaS business, but at the end of the day it boils down to just two options: private and broker.
You could also include DIY marketplaces on this list, but we tend to group those in with a private sale or a broker if that marketplace takes a commission. As a quick tip, if you are using a DIY marketplace that takes a commission from you, you may want to reconsider; often those styles of marketplaces are going to take the same commission percentage, or pretty close to the same, as a full-fledged M&A broker like us.
Let’s look at these two approaches.
Selling Your SaaS: the Private Route
Selling your SaaS the private route is exactly as it sounds.
You don’t use a broker or commissioned marketplace. You’re doing all the legwork yourself. On the surface, the private route sounds like the best route. After all, you don’t have to pay any commission and therefore get to keep all the profit from the sale.
When you dive a bit deeper though, going private has some significant drawbacks that may end up costing you more money than going with an M&A brokerage.
These hidden costs come in a few different forms.
First, you’ll need to find a targeted list of potential buyers. Then you’ll need to start the marketing of your business. You will also probably have to build some kind of filtering process to qualify those potential buyers, as you’re going to run into a lot of tire kickers along the way that will either waste your time or, worse, seek to steal intimate customer data from you.
Next, you’ll have to prepare all of your books yourself, such as your profit and loss statement and a workable prospectus. While you should have clean financial books already, creating something that is attractive to buyers can be an ambiguous task if you’re not familiar with the process.
After this, you still have to do all of the negotiating by yourself. If you’re not good at negotiations, you may get talked down on price or end up offering a level of support you regret post-sale. Speaking of price, it is also very likely you’ll pay the cost of going private by simply selling your SaaS business for a lower price than you would have with an M&A broker. A big reason why this happens is simply because you are not experienced in the day-to-day of selling businesses. For you, this is a highlight event that happens maybe once or twice per year if you’re an extremely prolific entrepreneur.
Brokers, on the other hand, are selling digital assets every single day of the week—it’s their entire business.
When you are selling a business as a highlight event, it is likely you are going to price the business wrong. Plus, buyers on the private side of acquisitions are looking for undervalued businesses. It is one of the big reasons why prolific buyers spend so much time building out private deal flow in the first place. They’re counting on you not being able to price your SaaS business correctly so they can get a better deal.
Once the deal is brokered, you still have to have the correct processes in place from legal, escrow, or an escrow-like service for the payout, and you have to actually migrate the business over to the new owner.
All of this can be a huge time sink when all you really want to do is focus on your next big project or idea.
The one caveat here that makes private make sense is if you’ve built up an audience of people that are obvious potential buyers. In this case, you may have some of the hard parts taken care of for you in terms of marketing, and your perceived thought leadership may allow you to command a premium valuation price.
The majority of entrepreneurs do not have this, nor all the other skills that can make selling a SaaS business easier.
There is absolutely nothing wrong with going the private route, just keep these obstacles in mind if you decide to go down this path.
Sell Your SaaS Using an M&A Broker Advisory Firm
The second route to selling your SaaS business is using an M&A broker advisory firm like us. When you decide to sell your business with us, you get to command an entire panel of expertise you would not have access to going the private route.
Reputable brokers have spent heavy investments in crafting a database of qualified buyers, accredited investors, and entrepreneurs looking to make strategic acquisitions. The database itself can save you untold amounts of time. You also benefit from the filtering processes already in place to make sure you are spending time with people that have the real legitimate potential to buy the business, rather than people just taking a look.
Brokers understand how valuations work and they know what the market is willing to pay, and thus it is likely you will make more money going with a broker even after you pay the commission when the broker sells your SaaS business.
Next, you’ll be able to leverage a broker’s sales team. These are trained negotiators that act as a kind of intermediary consultant between you and the buyer. A broker’s incentives are in alignment with you as a seller in that they want to help you get the maximum price for your business. Of course, good brokers will also want to give the buyer a reasonable deal.
The broker’s fiduciary responsibility is to you as the seller, but they understand it is good business to treat buyers well since buyers are often prolific customers of brokers. Often these buyers have amassed a sizable amount of personal net worth or have raised significant capital that they are deploying across multiple different acquisition targets at any given time. Brokers that want the buyer to succeed are also the best type of broker to work with as a seller because it means they’ll have access to a vast number of buyers, which can significantly widen the pool for you.
Outside of negotiations, you’ll also receive help migrating the business from yourself to the new owner. As of this writing, we are the only broker that has a fully dedicated migrations team to not only help you transfer the asset, but also to help you handle any sort of earn-out payment schedule that comes along with a specific buyer’s deal structure.
In addition, you’ll have access to our in-house team of legal professionals, agreement templates, and so on to make the process as smooth as possible.
If this is your first time selling a business, we highly recommend using an M&A brokerage like ourselves. There are a lot of moving parts when it comes to selling a successful SaaS startup business. The last thing you want to do is leave it up to chance and go it alone if you’ve never had any previous experience. Whether you end up using us or someone else, we believe this is likely the best path for a first-time seller.
If you have sold many businesses before and are familiar with the different intricacies involved, then using an M&A brokerage can still make a lot of sense. In some ways, it is no different than hiring a content marketing or paid media digital agency to handle various aspects of your business. A reputable broker can become an integral and trusted member of your team when chosen correctly, and as already mentioned, making a broker part of your team could put more money in your pocket at the end of the day.
Who is likely to buy your SaaS business?
After all of this, you may be wondering…
Who is actually going to BUY your SaaS business?
Who are these investors?
Well, the answer to that question is deeply nuanced.
There are a ton of different buyer personas out there. In general, though, the most likely buyer of your SaaS business is going to be a non-technical buyer. They will probably have a limited knowledge of coding and will likely need the most help with this aspect of running the business in the post-sales support phase of the acquisition. It is possible that you’ll find a technical buyer, but that is rare.
The next generalization we can make is be prepared for a longer sales cycle than an e-commerce business or content site. The latter of the two business models is often simpler for a buyer to conceptualize running, even if that conceptualization isn’t based in reality. The best thing you can do to speed up the time to an actual sale is to focus on making the SaaS business more attractive and helping to instill buyer confidence in the success of the business.
The more you can position your business as the perfect solution for a buyer to reach THEIR goals, the better position you will be in to sell the business faster.
Don’t let your copywriting hat fall off at this stage.
You had to put on your copywriting hat to solve all the needs and problems of the customers that your SaaS business serves. Now, you need to do the same with the potential buyer. Ask yourself what their pains and desires are, what to achieve, and how best to position your SaaS business to be the obvious choice in helping them hit their personal and business goals.
Ready to Sell Your Saas?
As you can see, selling a SaaS business has a myriad of moving parts.
If everything goes well, you might have put yourself in the best position to make a truly life-changing exit. The capital you can get in your bank account from the sale of this kind of asset can level you up in a hundred different ways, many that may not be apparent at the onset.
All of that being said, selling a SaaS business can be a confusing or even a frustrating endeavor if you don’t know what you’re doing.
That is why we’re here to help you.
If you are looking to exit your SaaS business and want to have the best possible experience when you go to sell, then click here to schedule an exit planning call with us today.
The call will be helpful to you whether or not you use us to sell the business. At the end of the day, talking to our representative will help you create a much smoother business that is easier to run, even if you don’t sell it.
Plus, they’re free, and in our book, that’s a win-win.
If you’re ready to sell your SaaS business right now, then click here to start the selling process.