Valuation Multiples for SaaS Companies
Earlier this year a colleague at Scale Venture Partners, Andy Vitus, wrote an outstanding post on investing in software as a service companies, specifically, SaaS valuation multiples based on the initial CAGR (compounded annual growth rates) and how they predictably decline each year as the SaaS company matures. It is the expected rate of CAGR decline that then translates into what valuation multiples a VC firm should apply. Anybody that is connected to a SaaS company should review the material, A Valuation Framework for SaaS Companies : Scale Venture Partners.
Over the past several months many SaaS business owners have inaccurately referenced the article to indicate their valuation multiples expectations when discussing exit strategies with iMerge. Therefore we thought it imperative to add some color to this post and clear up any confusion.
Andy shows this chart (click to expand) that outlines how much revenues will grow over a 5 year period based on various growth decay rates (left column). The far right column is NOT a SaaS multiple for business owners to expect upon an exit. It is simply the multiple of revenue expansion over a five year period. Its important to keep in mind that the chart is intended to be used by early investors in SaaS companies as a general guideline. iMerge’s experience has shown that SaaS firm’s growth rate and its rate of decline vary widely. Many SaaS companies may have an initial growth rate that well exceeds 100% but find itself pretty quickly settling down faster than a rate of the “Low Road”. Ultimately most SaaS firms have found themselves within range of the growth numbers Andy depicts.
Since many of our discussions are with mature boot strapped SaaS firms with revenues between $10-$20 million and EBITDA of $2-$4 million we need to re-position expectations. If a SaaS firm has gone from a CAGR of 150% down to 20% in its 5th year it is going to be difficult to convince any buyer that the business growth will exceed 100% some day again under new ownership. Those SaaS business owners that are 3 to 5 years old will want to take their most recent CAGR and look at the light blue column headed with a O. Typically for these “mature” SaaS firms the expansion range will be from 1.9x to 3.0x. Meaning in 5 years the company’s revenues will be 2 to 3 times larger.
So what does all this mean to SaaS business owners and the offers they are likely to see when exploring an exit. Venture capital investors are looking to get 5 to 10 times return on their initial investment. Therefore the sector has to be or expected to become red hot and the SaaS company will need to show its ability to get way out in front with a proprietary, high entry barrier service with lots of differentiation. As noted in the chart for a VC firm to see an expected 5x + return (last column) the SaaS firm’s management team will have to strive for 70% growth with no more than 10% annual growth decay.
On the other hand, financial and strategic investors have a smaller risk appetite which means the more mature, albeit lower growth, SaaS companies can be appealing. Correspondingly, lower growth rates mean lower multiples.
To determine where the mature SaaS company falls on the multiples valuation chart note the highlighted red circle. The middle column is the 5 year revenue expansion rate, simply scroll over to the right to the EntryP/S column and that would provide an estimate of where the SaaS business valuation lies.
Lastly as an example (horizontal red line), a 5 year young SaaS company is showing a current 40% CAGR. The buyer expects the annual rate of decay to be 15% per year for the next 5 years yielding a 2.3x revenue expansion with the 5th year CAGR being 17%. In this case the buyer is likely to peg the valuation multiple at 1.8x revenues.
To learn specifically the valuation multiples for your SaaS firm, please contact us. Needless to say if you are looking for venture capital for your SaaS company contact Scale Venture Partners,.