How to value your bootstrapped SaaS company.
Terms and considerations you should know if you’re thinking about selling your SaaS now, or in the future, including SaaS valuation multiples.
By Chris Reedy
VP of Acquisitions
The short story on SaaS valuation
Ultimately, the market determines the value of your business. In other words, your company’s value is the point where what you’re willing to sell for, and what a buyer is willing to pay meet. Selling a business is really similar to selling a house in that way (though not at all similar in other ways that we’ll get to later!)
As a Founder, you obviously want to sell for the highest number possible, and a buyer wants to buy for the lowest reasonable number possible. But there’s a sweet spot where the Founder gets a dream exit — not just a good number, but also a good outcome for their customers and team — and the buyer gets a fair price. With 30+ acquisitions under our belts, and ongoing relationships with many of our Founders, we’re confident that we know a thing or two about that.
But how do you come up with a value range that covers that sweet spot?
First, since MRR is a SaaS metric that most Founders track, let’s look at how it impacts valuation.
This is one of the most common questions that we get, and an important one for Founders as they think about the value of what they’ve created, so we’ll start here.
MRR obviously impacts valuation and there’s a direct linear relationship between MRR and valuation. The higher your MRR, the higher your valuation will be.
Valuation multiples also tend to go up the bigger your business gets. So, a $200k MRR business is likely going to 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 is not the end of the story when it comes to valuing a SaaS. We discourage Founders from chasing a specific MRR number before selling if they’re otherwise ready for an exit because there are many other factors that impact valuation.
Profit is one major factor. A business that’s making $100k MRR that’s breaking even isn’t going to be as valuable as one with the same MRR that’s running at 40-50% profit margins.
Churn is another key signal that buyers are going to be looking at. 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 an important factor, but showing there’s profit, a great growth path, and low (or at least reasonable) churn are also going to be critical for any buyer looking seriously at your business.
Let’s jump in and take a deeper look at those factors and what else goes into how to value a SaaS company.
Beyond MRR: The basic math behind a bootstrapped SaaS valuation
Now that we’ve looked at how MRR impacts valuation, let’s dive into the math behind most SaaS valuations. If you’re looking for the most basic method of valuation, there are two simple formulas most buyers (and sellers) use as a starting point to determine the value of a SaaS company.
SDE-Based SaaS Valuation (Most common)
Seller’s Discretionary Earnings (SDE) x a Multiple
= Your Approximate SaaS Value
Revenue-Based SaaS Valuation (Less common)
Revenue x a Multiple
= Your Approximate SaaS Value
Let’s dive into SDE a bit more, and then we’ll look at cases where revenue might be used for SaaS valuation instead.
Calculating your SDE
Business profit before taxes
+ founder(s) salary
+ founder(s) benefits
+ adjustments for any other non-essential expenses
SDE is a metric you’ll want to be familiar with if you’re considering selling your SaaS.
If you follow the stock market at all, you’re probably already familiar with EBITDA (Earnings before interest, taxes, depreciation and amortization). It’s often reported in public companies’ quarterly earnings releases, and it’s one of the methods investors and financial analysts use to measure a company’s operational performance regardless of differences in things like industry, country, or region. It’s also sometimes used as a valuation method for big SaaS businesses with multiple employees and multi-million ARR stats.
SDE is similar to EBITDA in that it tries to remove taxes and non-cash expenses. It differs in that it also removes costs related to a founder’s dual role as both the owner and the operator of the business.
That’s useful for estimating how much a bootstrapped SaaS business is worth, because typically the founder works both on and in the business, and SDE accounts for that dual role.
That means the founder’s salary, as well as expenses like personal health insurance that usually come out of the company’s profit and cash flow get added back in.
These kinds of expenses benefit the current owner, and typically don’t get passed on to a new owner (at least in the same form), so they’re considered “discretionary.” In other words, they aren’t essential to operating the business.
Not sure if an expense is discretionary?
Here’s a quick checklist:
✓ It benefits the owner (like health insurance)
✓ It doesn’t benefit the business (like advertising) or the employees
(like hourly wages for a contract developer)
✓ It’s documented on your tax returns and P&Ls
Taxes also get added back into SDE because a new owner will likely have a different tax cost/structure, particularly 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, register your business, and draft contracts and IP transfer for a part-time developer and a couple other contractors. These legal fees are non-recurring, and would get added back into your SDE.
It’s important to note that your SDE will be calculated and verified using your tax returns and P&L’s, so you need to have your financial records in order.
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 full financial history of the business. (Here’s a more 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 SaaS?
Join our live, free webinar for bootstrapped SaaS founders and learn how to properly value your SaaS business. Learn the facts and myths about the valuation and acquisition process. Ask questions or just sit back and listen to the experts.
Ballparking long-term value with SaaS valuation multiples
Getting back to the original formula for valuing a bootstrapped SaaS business using SDE — 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 are a measure of the business’s long-term potential value.
For smaller, bootstrapped SaaS businesses (that are profitable and growing) valuation multiples tend to range between 3x and 5x.
Businesses with higher profit margins, TAM (Total Addressable Market) and YoY growth rates, and lower customer and revenue churn will have multiples on the higher end of that range.
On the outside of that range, a lower SaaS valuation multiple can come into effect if the business is flat, or declining. Or multiples could spike past 5x if your YoY growth is insane, or in a strategic acquisition (more on those in a moment).
However your current math works out, be careful that your margins and growth rate take into account your current reality. Sure, in theory any business has the potential to double in size in the next year. It also has the potential to lose half or 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.
It’s also worth noting that different buyers can put vastly different valuations on a business. Smart buyers aren’t just buying history, they’re also buying what they think they can help the business become in the future.
There’s going to 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 able to get more long-term value (and therefore be willing to pay a higher price) because there’s a good fit with other ways they’re already making money and/or serving customers.
That’s why ‘strategic’ buyers might put a purely revenue-based or even technology-based valuation on a company. But these types of buyers also typically only want to buy bigger companies, so they don’t usually come into play with smaller SaaS deals.
A purely revenue-based valuation also indicates that the buyer will radically change the operations and cost structure of the business they’re acquiring, 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 all the time 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 Founder of that company 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 happening. 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 are going to be first in line if and when they sell the company.
When a company is sold in an all-cash transaction, the Founder is completely taken out of the business over an agreed-upon length of time, and no longer has any risk in the business going forward.
So when you hear about a valuation, it’s important to know whether you’re hearing about a cash valuation, or a paper valuation. Because a paper valuation can sound very impressive, but it may have a lot of asterisks, and it has no direct relationship to a Founder’s bank account balance.
On the flipside, bootstrappers who haven’t taken outside funding and are usually looking to sell in a shorter time frame are more likely to get a full cash valuation and exit, but their valuation multiples may not make headlines like the Slacks and Hubspots of the tech world.
At SureSwift, we’re mostly a financial buyer — that’s why we price primarily based on earnings and use the SDE method for cash valuations — and we look to extend on 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 a bit more for companies we feel confident about growing.