Before you can sell your SaaS, you need to know what it’s worth. But how exactly do you value a SaaS startup? Here, we’ll explore a common approach to calculating the value of a SaaS business and discuss the various factors involved.
At FounderPath, we understand the importance of valuing and growing your SaaS. After all, we help bootstrapped SaaS founders get the capital they need to grow.
What is SaaS valuation?
A SaaS valuation is a way of determining the economic value of a SaaS. Investors or/and owners will want to take steps to value their startup for a number of reasons, not limited to:
- A valuation acting as a baseline for more informed decision-making, including in relation to strategies, marketing goals, and financial aims.
- Preparing to sell a startup with a grasp of what it is worth.
- Making preparations to sell a minority stake in your SaaS startup.
There are many ways of valuing a SaaS, but only some approaches are relevant to early-stage SaaS startups (which we’ll soon discuss).
Also, valuing a SaaS depends on a wide range of factors. These factors include:
- What industry you’re in.
- Your SaaS’s business model.
- Value proposition.
Common mistakes when valuing a SaaS
Valuing a SaaS can be a difficult task. Here’s a few things to avoid:
- Comparing your SaaS with a recently sold competitor – Looking at what a rival SaaS just sold for can be a misleading approach. It can be hard to identify whether they closed to a fair valuation or if they undersold their business. There are also so many factors involved, such as the founder’s negotiation skills, the terms they’d agreed upon, and the reason for purchase.
- Comparing your SaaS with the public market – As a small startup, the last thing you want to do is compare yourself to big brands on the public market. SaaS businesses can scale up disproportionately fast the larger they become, so doing this may lead you to valuing your business significantly above that of the market.
- Trying to apply a one-size-fits-all valuation approach – You can’t use approaches for other online business models. For instance, despite many similarities, SaaS and e-commerce startups have vastly different business operations and can’t be valued the same way.
How to value your SaaS
So, what steps will you want to take exactly? Let’s explore what’s involved in accurately valuing a SaaS startup in 2022.
Seller discretionary earnings (SDE)
The ideal valuation method for most SaaS startups’ will be the SDE method. This measure focuses on your startup’s cash flow. You can figure out your SDE by seeing what money is left once you (as the owner) have paid all relevant expenses for a given time period (e.g., wages, marketing, software, etc.). You will also want to add back your salary to the remaining cash flow.
As Bench.co puts it, you can calculate your SDE with the following equation:
SDE = (Net income before taxes + your personal draw + non-essential expenses) – your liabilities.
To put a microscope on the above equation, here is how you determine your net earnings before taxation:
Net earnings before taxes = Total revenue – expenses.
Ultimately, this can give you a clear sense of the earning powers of your SaaS. The SDE model is almost always preferable for SaaS startups.
You will need to go through plenty of financial data to calculate your total SaaS revenue and expenses. Good organization and record-keeping is key to ensuring accurate results. Tools like Stripe and ProfitWell can automate a chunk of the calculations.
Once you’ve determined your SDE, it’s time to multiply it by, well, the multiple. AYou can just multiply your average net revenue (or projected average net revenue) for a 12-month time span. However, it’s preferable to factor in your SDE instead.
By following the recommendations discussed toward the end of our “figuring out the multiple” subsection, you will then have everything you need to value your SaaS.
Again, in order to do so, you can use the following calculation:
SDE or average net profit for a 12-month period x the multiple = SaaS listing price.
Online valuation calculator
If you’d like to get right to the point, you may want to consider using a business valuation calculator. Here are some popular examples:
However, it’s generally best to do the calculations yourself if you want to get the most accurate valuation possible.
Figuring out the multiple
The multiple (in the context of SaaS company valuation) is part of the final calculation in determining what your SaaS is worth. It is the figure you use to multiply your SDE by so that you can establish a listing price.
If you’re less than a year old, you can make some financial projections to calculate your valuation.
For example, suppose you have five months of net profit data. You can then increase your entire net profit for that period by five and multiply it by twelve.
Alternatively, you can divide the multiple (after initially selecting it) by five and then multiply it by twelve. Either way, you’ll get the same result.
Let’s say you go with the former approach (of projecting your net profit for a 12-month timeframe). You will then need to select a suitable multiple for this equation.
We recommend a multiple of somewhere in the region of 8x to 16x. According to Kalungi, in 2020, the average private B2B SaaS business had a multiple of just under ARR x 12.
But how do you know what the ideal multiple is to use in your case? Here are some considerations worth noting:
- How involved you are – The truth is that the more involved an owner is in a SaaS, the more difficult it will be to sell. And the more challenging selling a SaaS is likely to be, the lower your multiple is going to be.
- Key SaaS metrics – You need to consider three core SaaS performance indicators when finding the multiple: churn, customer lifetime value (CLV), and customer acquisition cost (CAC). The stronger these figures, the higher you want to set your multiple and vice versa.
- How long a SaaS has been around – As a young startup, you’ll need to factor in your SaaS’ age when choosing a multiple. In other words, early-stage startups should go with a more conservative multiple.
- Growth trends – Investors will want to see clear signs of growth. The more your SaaS is growing, the higher you can put your multiple.
Choosing the right multiple for your SaaS may prove a bit time-consuming. It is also not very scientific.
Ultimately, you need to consider factors like those mentioned above and the average multiple range. But making the decision is more about getting a feel of the best multiple for your SaaS rather than making a precise calculation. Another way of looking at it is that the higher your SDE or average net profit, the higher you will want to set your multiple.
Again, here is the SDE x multiple formula:
SDE (or average net profit) for the previous 12 months x Multiple = Listing Price.
Alternative approach: the EBITDA model
The SDE model is preferable for SaaS startups since the EBITDA model is more suitable for established businesses with an annual revenue of more than $5 million. However, you may still want to learn a little about this approach.
In the case of the EBITDA model, you are calculating your net income by earnings. As mentioned, this model probably won’t suit your startup, but it’s worth some consideration.
The EBITDA model keeps account of Earnings before interest, taxes, depreciation, and amortization (gradually paying off the cost of an asset over time. These factors also make up the name, with their combined initials making EBITDA.
Some things to keep in mind when preparing to sell your SaaS startup
Whether you want to sell a stake in your startup or accept a full acquisition, there are certain steps you’ll want to take.
Our top tips for selling a SaaS startup:
- Presale phase – Before you can promote your SaaS to potential buyers, you need to value it. Beyond that, you must gather all the essential paperwork for selling a SaaS startup, whether in whole or as minority stakes.
- Market your SaaS – When marketing a SaaS, you have to know who is most likely to make an offer. By getting a sense of what buyers you are most likely to attract, you can tailor how you market your SaaS and who you market it to. In most cases, you will need the following steps to secure a deal; 1. A potential buyer approaches you, 2. You make your pitch, 3. Employ a relevant marketplace so you can make a sale, 4. Get a business broker on board.
- Evaluate your offers – Carefully consider any offers you receive before making a decision. Think about which option works best for you and what exactly you want to get out of selling your SaaS.
- Seal the deal – Once you’ve selected the right buyer for you, it’s time to make a deal. Make sure you are confident in the potential buyer before reaching this step, as you will likely be giving them access to confidential information before the deal is signed.
Sign up to FounderPath today
Today we discussed how to value your SaaS and what factors make up the relevant calculations. Whether you plan to sell your SaaS entirely or simply want to sell shares, you can still grow your SaaS in the meantime. And that’s where FounderPath comes in.
You can sign up for our service for free today. Along with the free edition, we also provide the following packages;
- Pro Edition – $250 per month
- Enterprise edition – $2,500 per month
However, even the paid versions come with free trials! This means you can get a taste of what either of these editions offer before deciding whether or not to commit financially.