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The value of SaaS is more than measurable. Find out how to evaluate a SaaS company with the many products you need for your next round of funding.
How To Value A Saas Business
The Software as a Service (SaaS) industry has exploded in recent years. And despite the economic concerns, it looks like the industry’s growth will soon slow down. Fortune Business Insights predicts that the size of the SaaS market will grow from an estimated $113.82 billion in 2020 to $130.69 billion in 2021 – and reach $716.52 billion by 2028.
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Every fast-growing SaaS company is trying to carve out a niche in this huge market – trying to become a global unicorn or even an outfit. But evaluating SaaS is difficult, so financial leaders and managers must work together to find the best way.
As you raise that next round of funding, this SaaS decision guide will help you look at your company’s financial and market fundamentals and make the right decision.
SaaS valuation is a valuation process that determines the current and future value of a SaaS company based on growth. The way investors view growth changes as a company matures. In the early stages, the first things are market efficiency and growth. When you get to the next round of funding, metrics like net cash retention and free cash flow come into play. But in all cases, the biggest driver of value is the growth rate. Inside, the SaaS company decision process begins with an assessment of what your company needs and wants from its next round, whether you’re pre-funding, participating in a Series C or pre-IPO funding round. Determine your financial goals by asking the following questions:
A strong financial planner can perform scenario analysis to provide more realistic answers to these questions. They work with founders and managers to map out the base, worst and best cases for expansion.
The Saas Rule Of 40
Capital and finance are always in dialogue with each other in a funding round: in each round, the company offers equity to investors – but if the company goes public, you don’t want to give too much, while the founders of the company don’t have any stake/rights in the company. That’s why you should always look to the next round of funding, even as you plan your current team—part of which is your cost metrics.
Setting the right benchmarks and benchmarks can impact future funding rounds: If you don’t hit your benchmarks or measure your growth accurately, you’ll lose the trust and interest of current and future investors.
What matters to an investor looking for a company to pre-fund is different from a company going to Series C. That’s why founders need to consciously enter the fundraising process.
Pre-revenue companies don’t go through a valuation process – they pay what the founder asks for. If a founder wants to raise $5 million and isn’t willing to give up 10% of the business, it’s valued at $50 million. Until you reach the later stages of growth, top-down work is more valuable than bottom-up work.
Software (saas) Value Proposition
Investors can post their queries based on factors like product category and current market conditions. Comparing your company to competitors and looking at your total addressable market (TAM) can help you understand where you fit in the market and what makes you different.
While good marketing is important, what really sets a SaaS company apart are the voices behind it. Entrepreneurs drive the unique story behind their business and can add value by bringing their vision to life for investors.
But that doesn’t mean early-stage deals are a shot in the arm for developers. Developers (and seed sponsors) also need to anticipate growth.
In many cases, this means going deep into cash flow analysis, calculating burn rates/tracks, and chapter planning to show how the company will move from cash flow to high growth.
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As the company progresses through its first round of funding, the focus shifts to revenue growth. The higher the earnings, the better the company looks to investors. That’s why the Series B round aims to show investors where the growth is and how they can contribute to building an amazing business.
Jason Lemkis, founder of SaaS community SaaStr, believes the best revenue growth occurs in the “T3D2” (triple-triple-triple-two-two) model. When a company makes $1-2 million in revenue, it should triple that revenue in the next three years and double it in the next two years.
This is essential to stand out in today’s crowded SaaS field. There are now more than 300 SaaS and cloud unicorn companies in the world. Now the rafters have changed – what investors are really looking for is the next outfit.
In Series B, companies have proven they can attract customers and grow revenue. For Series C and beyond, focus on higher revenue, net revenue retention (NRR) and profitability – your ability to continue to strengthen the cycle on the road to IPO.
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NRR has become the gold standard for measuring growth because it gives clarity to investors about the value of life.
A strong NRR means longer customer lifetime and higher LTV. As a result, your company spends more money to acquire customers than competitors with lower NRR. And if you have a high NRR in that 120%+ range, your CAC will increase exponentially, which means you’ll spend more effort acquiring customers.
When approaching an IPO, combining revenue growth figures with this kind of deep insight into capital gains is an important decision. A company growing 50% per year with a 4x LTV:CAC ratio is a better investment than a company growing 75% with a 1.5x LTV:CAC ratio.
If you had to sum up what makes SaaS profitable, it would be hard to argue with revenue growth, revenue retention and profit margin as drivers.
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The decision-making process may vary depending on whether the company is private or public, or in the status of a merger or acquisition.
Companies of all sizes can use customer acquisition cost (CAC) and customer lifetime value (LTV) to inform investors about how well their business is doing. How easy is it to attract customers? What value will they bring to your business over time? And what are your customer retention and churn rates telling you? A deep understanding of CAC shows what marketing and sales costs are worth so that a product outperforms expectations and closes deals. And as your company matures and you collect more historical data, you can calculate the CAC payback period based on cash flow to show investors how long it will take to pay off your selling costs. Determining LTV requires a lot of information: when they buy the product, what their contract terms are, and upgrades, downgrades and renewals. But it is worth the effort because the measurements will show the strength of your product and services. Investors (and for those looking to buy, potential buyers) want to look at the potential LTV:CAC ratio because it’s important to understand and predict the long-term sustainability of your business. There is an added layer of security not only in terms of funding but also in how the product helps customers run their business.
Valuing the right SaaS company depends on knowing that as your company grows, the numbers will become more defined with each round. And as you progress, there will be more data to download.
Entrepreneur David Cummings is responsible for creating rapid SaaS pricing models that combine these metrics. His first tax return focused on ARR, growth rate and net income retention with 10 numbers:
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A later revision redefined the number as “market value,” which is determined by the company’s market value divided by the company’s revenue. Cummings also sees benefits in the form of plant growth:
In addition to the investigation, Cummings simplified his method with the SaaS Rule of 40, which balances growth and profitability with financial burn.
Total SaaS Rule of 40 = Growth Rate % + Profit % With growth and profit specified, the Cummings formula now shows the most accurate value:
There are many aspects of marketing by recording ARR business size. The rule of 40 takes into account burn rate along with profitability, making estimates more accurate.
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Developers and financial leaders can go down a rabbit hole of complex calculations and assumptions when trying to determine the right price.
But if you find a way to continue in the funding cycle on a consistent basis, it will be easier to stand up for your own values and get the value you need. Let’s get one thing straight – raising money as a startup leadership team is not easy. However, the following
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