Here's What Buyers Look for in SaaS Businesses - Deepstash
Here's What Buyers Look for in SaaS Businesses

Here's What Buyers Look for in SaaS Businesses

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Here's What Buyers Look for in SaaS Businesses

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It’s a Valuable Asset

Whether you created your SaaS product to help solve a problem you had or because you wanted some extra income, the truth is that your SaaS business is a valuable asset.

Whether you’re an early-stage founder or you’ve built up an established B2B SaaS business, it's crucial to understand how valuations work and how you can prepare for an exit when the time is right for you.

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Valuing SaaS Companies Based on SDE, EBITDA, and MRR

There are three ways to look at SaaS valuations:

  1. Seller discretionary earnings (SDE)
  2. Earnings before interest, taxes, depreciation, and amortization (EBITDA)
  3. Monthly recurring revenue (MRR)

No matter which formula you use, they boil down to how much money your SaaS business generates and set that number against a multiple that reflects the quality of your business.

For SDE and EBITDA, you would set annual profit against an annual multiple; typically, this multiple ranges from 2-10X.

MRR is set against a monthly multiple that usually ranges from 25X to 100X.

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SDE reflects how much money your business makes after all expenses are paid and any salaries are added back into the business.

The figure is one way to indicate a business’s earning potential and is often confused with EBITDA.

Businesses valued with SDE tend to earn less than $2 million in annual recurring revenue (ARR) and tend to be run by solopreneurs. Year-on-year revenue growth is usually less than 50%.

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Businesses that make over $5 million in ARR will likely use EBITDA, as the business will have a high growth velocity and a more fleshed-out infrastructure.

The owners tend to be thought leaders in their industry and operations are developed with department heads and teams working under them.

There are usually more stakeholders than the owner. EBITDA takes many factors into consideration, which is why this metric is more suitable for mature and complex businesses.

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MRR is a popular way to value SaaS businesses because it’s a key indicator of revenue growth.

Investors prefer looking at MRR rather than ARR because annual recurring revenue doesn’t provide proof of churn.

Big SaaS brands generating high MRR can raise a lot of money during seed funding rounds, despite not generating profit. For less mature brands that haven’t built up a name, people prefer monthly plans; with a recognizable brand, they can charge a discounted annual plan.

A newer startup could be valued using MRR if it’s experiencing rapid growth and ARR is more than $2 million.

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The Three Key Elements of Attractive Assets

No matter which valuation formula is used, investors look for proof of these three characteristics in a business:

  1. Transferability
  2. Sustainability
  3. Scalability

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Investors look for businesses that can be easily transferred. To prepare your business for a sale, focus on making the transition as seamless as possible. Payment processing can cause huge headaches for buyers if the account can’t be transferred.

Payment processing aside, you’ll need to document your business operations as much as possible to make your business plug and play. Creating well-documented code that can be understood by another developer ensures continuity if the new owner wants to develop the product or fix any issues.

Standard operating procedures (SOPs) help buyers to learn how to run the business as you did; SOPs are great for training new staff or to refer back to during the transitional period when the business changes hands.

While buyers are doing their due diligence, they’ll need to see clean financials. This will include tax returns from the past three years, a balance sheet, income statements, and cash flow.

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Scaling your revenue (MRR) is great, but it needs to be done efficiently.

A business with high MRR won’t be worth as much if the churn rate is through the roof and your retention rate is poor. Buyers pay attention to your LTV, churn rate, and conversion rate optimization.

Investors will also look at how efficient your operations are at acquiring new leads. Organic lead generation is highly attractive because there are no expenses involved; if you have other customer acquisition channels (CACs), the conversion rates will indicate whether these marketing channels are worth maintaining.

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The most exciting prospect of SaaS businesses is their room for growth.

Buyers will be looking at how scalable your business is based on a number of factors, such as the LTV/CAC ratio.

A low LTV/CAC ratio may indicate that more capital is needed than expected to scale a business; on the other hand, a high ratio could mean your growth is slower than your competitors because you aren’t spending enough on marketing.

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  • Competition  - is there enough differentiation from existing software companies?
  • Product lifecycle - does your product need any major updates to stay relevant?
  • Technical knowledge - does the new owner require deep technical programming knowledge to be able to run the business, or can that knowledge be easily transferred?
  • CAC per channel - how effective is your marketing strategy at generating new customers in a cost-effective way?
  • Diversification - how many single points of failure are there in your business?
  • Saturation - is there room for growth in the current market?

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CURATED BY

kerem

ぬ-shaped person: Passionate learner having diverse interests. Tech entrepreneur. Obsessive optimizer. Uncomfortably skeptic and curious. Suffering from tsundoku.

CURATOR'S NOTE

If you're thinking an exit strategy from your SaaS startup, you have to be prepared for it.