How is a SaaS company valued?

SaaS valuations happen at key moments in a SaaS company’s life cycle, for example when it raises funds or is sold.

But what are the criteria for a SaaS valuation? Technology? Growth potential? An EBITDA multiple?

In this article, we present the main methods for valuing SaaS, with concrete examples. Then, we'll look at how you can optimize the company's value.

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1 - How do you carry out a SaaS valuation?

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Whether a software company is looking to raise capital from investors, bring in a new partner, or sell to secure its shareholders' assets, valuation is an essential step. Here's an overview of the methods used in financial circles, particularly for SaaS startups.

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1.1 - What is the valuation of a SaaS startup?

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A valuation is the estimation of a company's financial value based on its performance and prospects.It enables us to obtain the value that accrues to the company's shareholders.

This value forms the basis for negotiation when raising capital or selling a business. It defines the economic terms of the transaction (notably shares dilution), as well as estimating the owner's assets.

Whatever the method used, in the end the company's value always corresponds to the price a buyer is willing to pay. It is therefore important to compare the estimates obtained with the reality of the market or ecosystem (see studies on valuations for your sector, like this one by Avolta).

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1.2 - Valuation methods for SaaS startups

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Setting aside the launch phase, when a company does not yet have a product or service to market, valuation methods are generally based on financial data.

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a - Some traditional company valuation methods

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• The net book value method consists in valuing assets and liabilities to determine net worth. It involves an adjustment of various accounting items, such as the elimination of non-values, revaluation of real estate, integration of leases, etc.
• The DCF (discounted cash flow) method corresponds to the sum of  discounted future cash revenue. This valuation is therefore based on forecast data and parameters that are difficult to assess, notably the  discount rate.
• The multiples method involves valuing a company by multiplying a financial aggregate (customer sales, ARR, EBITDA, etc.) by a coefficient. By analyzing the valuation levels of recent transactions and listed companies, it becomes possible to identify the prevailing market multiple for a sector or type of company. For example, the average ARR multiple for listed SaaS companies in the USA was 10.7x at the end of 2021. However, this multiple needs to be adjusted to reflect the characteristics and prospects of each company.

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b - Estimate the value of a SaaS using the multiples method

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SaaS companies most often use the multiples method for their valuations.

The aggregate often used is ARR (annual recurring revenue). In the French SaaS sector, the median multiple is around 5times ARR (source: Avolta Partners).

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c - Valuing startups: examples

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KeyBanc Capital Markets' 2021 SaaS valuation study highlights multiples that fluctuate according to the level of aggregates used. For example, the average multiples observed from the companies surveyed were:

• 6 for an ARR of $5 to $10 million;
• 8.7 for an ARR of $10 to $25 million;
• 12 for an ARR in excess of $100 million.  

Here are two examples of SaaS valuation:

• United States: MyLeon.co is valued at $18 million, 7 times its ARR of $2.6 million (source: Founderpath).
• France : Alan was valued at €2.7 billion in May 2022, i.e.around 13 times its ARR of €200 million (source: Maddyness).

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d - Mixing several parameters to value SaaS

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Generally speaking, it's advisable to mix several valuations and compare the results obtained, to better determine the final value relative in the current market. With various valuation methods, SaaS founders have several financial elements at their disposal. They can then begin potential negotiations, whether to raise capital or to sell.

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2 - What criteria are used when valuing a SaaS?

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Several criteria will determine the value a potential investor or buyer is prepared to pay. They will be analyzed in detail to determine which valuation multiple is best suited to the situation.

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2.1 - MRR growth

A company's valuation is closely linked to its growth prospects. To estimate this, investors rely primarily on the past  growth rate, as this demonstrates the SaaS's commercial momentum (i.e., its ability to increase revenues from one period to the next). A high growth rate is a sign that the product is meeting a demand, and that the company will eventually be able to increase its revenue.

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2.2 - The 40% rule for valuing a SaaS business

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MRR growth is relevant. However, it is not always sufficient to determine valuation. In particular, it provides no information on the profitability of a SaaS. It may also conceal a disproportionately high CAC (customer acquisition cost). 

The so-called "40% rule" is a useful addition to estimating the value of SaaS. It combines MRR growth with profitability (EBITDA margin). A company that exceeds the 40% threshold is often awarded a higher multiple than one that remains below it (source: McKinsey), the reason being that a company above this threshold combines a favorable growth rate with an acceptable level of profitability.

💡 Use the 40% rule to ensure multiples better reflect the value of a SaaS.

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2.3 - Net revenue retention (NRR)

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This indicator is one of the main KPIs for SaaS valuation. It measures sales performance with existing customers. It calculates the revenue from existing customers over a given period.

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It therefore corresponds to the MRR at the start of a given period, minus the MRR lost (churn and revenue contraction) and plus the MRR gained thanks to the expansion of the period. This amount is then added to the start-of-period MRR to produce a rate.

If NRR is more 100%, the company is able to compensate for MRR losses due to churn and contraction through its ability to upsell. In this case, a company is able to grow its MRR solely with existing customers,demonstrating both resilience and significant growth potential. This metric is therefore important in determining the valuation of a SaaS.

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The SEG SaaS Index features a graph highlighting net retention versus market multiples (EV/Revenue ratio) for 21 companies. The average EV/Revenue multiple for this cohort was 16.7 (excluding Zoom's exceptional value). Companies with a net retention of 130% or more had an average EV/Revenue multiple of 21.9.

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3 - Optimize SaaS valuation with solid KPIs

Knowing and using the right valuation methods for a SaaS startup is a good thing. But you also need robust, optimized management data on which to base your calculations.

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3.1 - Reliable,auditable figures

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SaaS startups wishing to raise funds need to be able to base their company valuations on solid figures. Investors analyze these figures to gauge financial performance. They also check the reliability of data, particularly in terms of sales, customers, and marketing. They also analyze risk, no matter whether you’re a Series-C unicorn or a seed-stage startup.

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SaaS managers therefore need to equip themselves with tools that help them structure their data and make it more reliable. Online solutions like Fincome’s generate automated reports for them, so they can concentrate on running their business and analyzing their KPIs.

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3.2 - Standardize ARR calculation to optimize valuation  

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Standardization enables you to correct your ARR so that it gives a more realistic view of your how your company is doing. Many levers exist, depending on the specifics of your model.

A first lever your SaaS company can use is to correct for discounts or rebates occasionally granted to customers during marketing campaigns. These temporary rebates can be considered as one-off items that are skewing the calculation of ARR. By adjusting for these rebates, the ARR used to calculate the company's value is increased.

💡Use the multiples method to increase your the valuation.

A second lever is to take all subscriptions that have been agreed (with signed contracts or purchase orders) but not yet invoiced and include them in your ARR. In this way, you can present a pro forma ARR of your latest customer sales wins.

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Knowing how to correctly value your SaaS startup is crucial (whether or not the value reaches several million euros). To maximize your chances, choose the right tools for monitoring your KPIs. Take a free demo to see how Fincome can help with your SaaS valuation.

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💡 Complete your reading with the following articles:

• 3 common mistakes that kill SaaS startups
• Top tips for communicating with SaaS investors
• Automated reporting for SaaS: a quick guide
• KPI reporting at every stage of your startup
• Why is SaaS financial reporting still crucial for your startup in 2023?