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- What is my SaaS worth?
Everyone loves simplifications. This also seems to apply to SaaS founders and company valuations.
“We are at $3M growing 10%, can you tell me what ARR multiple I can expect?”
I get messages like this all the time. Unfortunately, it's not that simple.
Misconceptions in Private SaaS Valuation
From my experience, a common misconception among founders is the reliance on valuation multiples like EV/ARR or EV/TTM Revenue as the primary determinant of their company's worth.
They often attempt to estimate their company's value by applying public SaaS valuation multiples or even VC multiples.
Others have heard that a competitor sold for X, or know a friend who sold for Y, and think they could demand a similar multiple.
However, the reality is that SaaS valuation multiples just serve as comparative tools for assessing SaaS businesses of varying sizes.
They are a reflection of a company's intrinsic value, not the other way around.
The Foundation of SaaS Valuation
The intrinsic value of a SaaS company is essentially the present value of its future cash flows.
The key factors that determine the present value of these cash flows include their size, their timing and the associated risks.
Let’s take a simple example:
You acquire a $5M ARR break-even SaaS business for $25M (5x ARR).
It continues to grow 20% y-o-y and you sell it after a 5-year holding period for 7x ARR (~$87M).
Exiting the business will bring you a 3.5x Multiple On Invested Capital (MOIC) - or an Internal Rate of Return (IRR) of 28.5%.
As a reference, private equity buyers usually aim for a 3x MOIC in 5 years (~25% IRR).
So it looks like a good deal, right?
Now let's assume that you can make the company profitable so that it brings in $1M in cash every year during the holding period (+$5M in total).
Your MOIC would go up from 3.5x to 3.7x (IRR = 29.9%). Even better!
Obviously, these are just veeery simple examples showing two of countless possible outcomes. There is also a lot that could go wrong here.
Determining factors of SaaS Valuation
Investors (including saas.group) often employ very complex models that take numerous factors into account and run different scenarios to forecast cash flows and derive what they are willing to pay for these future cash flows today.
Factors considered include both quantitative elements such as historical financial data and SaaS KPIs as well as qualitative factors. Below you will find a list of the most important ones.
Source: Software Equity Group
Other factors such as the macroeconomic climate, the cost of the debt / equity, and the investment strategy (buy&sell vs. buy&hold) also play a role.
To pick up on the example above, maybe…
Growth of the business has been declining recently,
Some key employees have just resigned, and/or
There is high client concentration, and/or
There is strong emerging competition, and/or
Macroeconomic outlook is poor, and/or
It’s an old business and there is a lot of technical debt.
Together, this could lead you to the conclusion that the scenario described in the example above is far too optimistic.
Accordingly, you may only want to put a 4x ARR or less on the table for the deal to keep the risk-return ratio at a reasonable level.
As a rule of thumb:
📉 High risk that there will ever be significant cash flows = low multiple.
📈 Low risk of very attractive cash flows in the future = high multiple.
That's why a flat PLG SaaS business with high churn that hasn't made a profit in the last two years trades at 1xARR, while a growing company with a mission-critical product, a great track record and excellent customer retention metrics sells for 5xARR+.
As a founder, you can do the math yourself. Just create a proper cash flow model and play around with the numbers yourself.
This will certainly give you a better idea of your company's valuation than looking left and right.
Key takeaways
Multiples are a reflection of a company's intrinsic value, not the other way around.
Intrinsic value of your SaaS = the present value of its future cash flows.
Buyers are usually looking for a 3x+ in 5 years (25%+ IRR), which determines the price they are willing to pay for future cash flows today.
High risk that these cash flows will materialize = low multiple, low risk = high multiple.
⚠️ Disclaimer: Calculations may contain errors and are intended as simplifications. Always verify with reliable sources.