SaaS Valuation Multiples: How to value a SaaS company

Terms and considerations you should know if you’re thinking about selling your bootstrapped SaaS now, or in the future, including SaaS valuation multiples.

How to value a SaaS company, including factors that impact SaaS valuation multiples

If you’re a bootstrapped entrepreneur, figuring out how to value a SaaS company can be a challenging endeavor. It’s important to get it right since an undervalued company can be a missed opportunity and an overvalued company can lead to strife. So, how do you go about it?

To help, we created this guide on how to value a SaaS company. We’ll take a look at some of the most common SaaS valuation methods like MRR and churn rate and see how they apply to your company. Depending on the circumstances, different approaches may work better than others.

The short story on SaaS valuation

Ultimately, the market determines the value of your business. In other words, your company’s value rests on the price a buyer is willing to pay for acquiring your business and the price you’re willing to sell it for. Selling a business is similar to selling a house (though not at all similar in other ways that we’ll get to later!).

When it comes to SaaS valuation, there's a sweet spot where the buyer's and seller's prices meet. The founder gets a dream exit, and the buyer gets a fair price.

As a Founder, you obviously want to get the highest number possible when selling your company. A buyer wants to get the lowest reasonable number possible when buying your company. There’s a sweet spot where the Founder gets a dream exit — a good number and a good outcome for their customer and team — and the buyers get a fair price. With 30+ acquisitions under our belts and ongoing relationships with many of our Founders, we’re confident at SureSwift Capital that we know a thing or two about that.

But how do you come up with a value range that covers that sweet spot?

Thinking about selling your profitable business?

If you’re thinking about selling your SaaS we’d love to be on your radar and answer any questions you might have about valuations or our process.

MRR Valuation Multiples

How does MRR impact SaaS valuation? First, since MRR (Monthly Recurring Revenue) is a SaaS metric that most Founders track, let’s look at how it impacts valuation.

This is one of our most commonly asked questions and an important one for a Founder to consider when thinking about their company’s value, so we’ll start here.

MRR impacts valuation, and there’s a linear relationship between MRR and valuation. The higher your MRR, the higher your valuation will be.

Valuation multiples also tend to go up as your business grows. So, a $200k MRR business will likely have a higher valuation multiple than a $20k MRR business, and that business will have a higher multiple than a $2k MRR business.

However, MRR isn’t the end of the story for valuing a SaaS. There are other factors to consider, so we try to discourage Founders from chasing a specific MRR number before selling if they’re ready for an exit. 

Profit is one major factor. A business making $100k MRR and breaking even isn’t as valuable as one with the same MRR running at 40-50% profit margins.

Churn is another key signal that buyers look at when deciding whether to buy. There’s no “right” number, and churn can vary widely depending on your product and niche — but generally speaking, the lower the churn rate, the better.

So, yes, MRR is a significant factor for any buyer looking to purchase your business, but so is showing a profitable revenue growth path and a low churn rate. 

Next, let’s review these concepts and what else goes into how to value a SaaS company.

Beyond MRR: The basic math behind a bootstrapped SaaS valuation

Let’s now look at how MRR affects SaaS valuations, starting with the math behind most SaaS companies’ valuations.

To determine a SaaS’s value, there are two basic formulas most buyers (and sellers) use as a starting point. 

SaaS valuation multiples are often based on SDE, or seller's discretionary earnings

Most Common: SDE-Based SaaS Valuation

Seller’s Discretionary Earnings (SDE) x a Multiple
= Your Approximate SaaS Value
Sometimes a company will base SaaS valuation multiples on revenue instead of earnings

Less Common: Revenue-Based SaaS Valuation

Revenue x a Multiple
= Your Approximate SaaS Value

A closer look at SDE

Calculating your SDE is the basis for understanding how to value your SaaS company

Calculating your SDE

Business profit before taxes
+ Founder(s) salary
+ Founder(s) benefits
+ depreciation
+ adjustments for any other non-essential expenses

Let’s take a closer look at SDE, and then we’ll look at cases where revenue might be used for SaaS valuation instead.

SDE, Seller’s Discretionary Earnings, is a metric you need to know if you’re considering selling your SaaS.

If you follow the financial markets, you may know Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). Most companies report their EBITDA in their quarterly earnings reports. Investors and financial analysts use these reports to measure a company’s operational performance regardless of changes in things like industry, region, or country. It’s also sometimes used as a valuation method for big SaaS businesses with multiple employees and multi-million ARR (Annual Recurring Revenue) stats.

SDE is similar to EBITDA in that it attempts to remove taxes and noncash expenses from total earnings. Still, it differs in that it excludes costs associated with a Founder’s role as both an owner and operator of the business.

That helps estimate how much a SaaS startup is worth because typically Founders work both on and in their startups, and SDE accounts for that dual role and the fact that the Founder has a salary.

And that means that expenses typically coming out of the company’s profit and cash flow, like the Founder’s salary and health insurance, get added back in.

These expenses benefit the business owner and usually aren’t passed on to a new one, so they’re discretionary. In other words, they’re not essential to running the business.

Not sure if an expense is discretionary?

Here’s a quick checklist:

✓ It benefits the owner (like a health insurance plan)

✓ It doesn’t help the business or the employees

(like hourly wages for a contract developer)

✓ It’s documented on your tax returns and P&Ls (Profits & Losses)

Taxes also get added into SDE because a new owner may have a different tax structure, mainly if they’re operating multiple businesses.

And finally, adjustments are made for one-time, non-essential expenses. For example, let’s say you’ve been in business for two years. In your first year, you hired a lawyer to help you set up an LLC (Limited Liability Company), register your business, and draft contracts and IP transfers for a part-time developer and a couple of other contractors. These services cost legal fees, which are not recurring, and get added back to your SDE.

Ensure you keep your financial records since SDE is calculated and verified using your tax returns and P&Ls.

If you’ve been in business for more than 3 years, expect to share the last 3 years. If you’ve been in business for less than 3 years, expect to share the entire financial history of the business.

Here’s a complete list of what you’ll want to have done if you’re serious about preparing your business for an exit.

Thinking about selling your profitable business?

If you’re thinking about selling your SaaS we’d love to be on your radar and answer any questions you might have about valuations or our process.

Ballparking long-term value with SaaS valuation multiples

Let’s go back to the original formula we used to value a bootstrapped SaaS using SDE as it’s time to look at the multiplier part of the equation. If SDE is an attempt to measure how much cash a business can bring in to a new owner, then SaaS valuation multiples measure the business’s long-term potential value.

For smaller, successful bootstrapped SaaS businesses, valuation multiples tend to range between 3x and 5x.

Businesses with higher profit margins, TAM (Total Addressable Market) and YoY (Year-over-Year) growth rates, and lower customer and revenue churn will have multiples on the higher end of that range. 

SaaS valuation multiples infographic
A lower SaaS valuation multiple can come into effect on the outside of that range if the business is declining. Or multiples could spike past 5x if your YoY growth is exponential, or can also spike in a strategic acquisition (more on those in a moment).

When calculating using the formula, be careful that your margins and growth rate consider your current reality. Sure, in theory, any business has the potential to double in size in the next year. However, it also has the potential to lose half or even all of its customers in the next year.

When would a revenue-based valuation be used for a SaaS company?

If a company is in the very early stages when it’s acquired, or it’s growing more than 50% YoY, it may make more sense to do a revenue-based valuation since there’s not a stable history to look at with SDE.

Also, different buyers can put vastly different valuations on a business. Smart buyers aren’t only buying history; they’re also buying potential or what they think they can do to help the business.

There will be a big difference in the “fair” price between buyers that might bring very different goals, assets, and strategic direction to a given business. One oversimplified way to look at this is that some buyers are strategic, and some are financial.

Strategic buyers may be willing to pay a high price for a company because there’s an alignment between their existing business models and the new one.

Strategic buyers might put a purely revenue-based or even technology-based valuation on a company. Typically, these buyers only want to buy larger companies and don’t settle on smaller SaaS deals.

A purely revenue-based valuation indicates the buyer may radically change the operations and cost structure of the business they acquire, so they ignore the current ops and cost structure.

It’s also worth noting that there’s a big difference between paper valuations and cash valuations.

There are tons of SaaS valuation stories on Twitter and in the news with companies reporting they were just valued at 10x their revenue or higher.

But one key thing that a lot of Founders aren’t aware of as they hear those stories and start to think about an exit is that these valuations may be paper valuations and don’t mean that the company’s Founder is actually walking away from that business risk-free with that cash in hand anytime soon.

Paper valuations typically come into play based on a venture capital or even a private equity fundraising round.

In these valuations, there’s not a full exchange of cash or a full transfer of risk. And in fact, receiving a high paper valuation can even raise the bar the Founder needs to achieve for a profitable exit because their investors will be first in line if and when they sell the company.

An all-cash sale means that the Founder is completely removed from the business over an agreed-upon time frame, and no risk exists for the Founder’s future in the business.

So when you hear about a valuation, it’s important to know whether you hear about a cash valuation or a paper valuation. Although paper valuations may sound impressive, there may be many problems, and there’s no direct relationship to a Founder’s bank account balance.

Conversely, bootstrappers who haven’t taken outside funding and want to sell in a shorter time frame are more likely to get a total cash valuation and exit. Still, their valuation multiples may not make headlines like the Slacks and Hubspots of the tech world.

At SureSwift Capital, we’re primarily a financial buyer — that’s why we price primarily based on earnings and use the SDE method for cash valuations. We also look to extend the strengths of bootstrapped SaaS companies by keeping and growing the teams who have made the company successful.

We think we’re pretty good at operating companies and extending growth, which means we can pay more for companies we feel confident about growing.

On your entrepreneurial journey, selling a SaaS company can be a complex process with many factors to consider. The market or the price buyers are willing to pay for your business, is one of the most important considerations. In this post, we discussed some key points to keep in mind when selling your SaaS company and what affects its value. Whether you’re just building your SaaS business from scratch and want to plan for the future or you’re going through the acquisition process now, we hope you’re now armed with the proper knowledge in making an informed decision about your future and the future of your company.

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