
How to Value a SaaS Business - ThomasSmale
http://feinternational.com/blog/saas-metrics-how-to-value-saas-business/
======
patio11
Adding a little bit of color commentary here (I sold BCC through FEI, the
authors of this post):

If you have N products, and ever want to sell any of them, _thoroughly
decouple_ the businesses from each other as early as possible. I spent weeks
getting BCC moved off of my other business' e.g. CDN accounts, Rackspace
account (required a server rebuild), MailChimp account (required an email
provider migration of a different project), etc. You don't want to be doing
this while you're doing either due diligence or handover -- it introduces
technical risk into a project which doesn't tolerate technical risk well.

I'm not one to worry overmuch about costs in the day-to-day operation of my
businesses, but several months before selling you want to take a quick look at
recurring expenditures and do a purge of any which aren't providing essential
business value. Four random SaaS expenditures totaling $200 a month disappear
into rounding error of a small SaaS business... but that's ~$10k chewed off
the sales price. You want to do this months before the sale to allow time for
the numbers to be reflected on your P&L statement and to justify, if asked,
"Yep, that isn't actually needed to successfully operate the business."

A surprising thing for me: the market expectation at these valuations is for
all-cash or almost-all-cash deals, rather than e.g. significant amounts of
seller financing (seller loans buyer money to buy business, collects it and
interest over time) or earn-outs (additional payments are due 6~24 months
later contingent on the business' performance post-acquisition). If your SaaS
is worth e.g. $400k, the expectation in the market is $400k cash or possibly
~$50k or so of financing/earnout and $350k cash. I naively assumed $100k cash
and $300k financing would be a common term; it appears this is not the case.

Speculative expenditures in growth which you're not capable of utilizing for
e.g. owner bandwidth reasons are a really, really bad idea to buy in e.g. the
last year, particularly if those expenditures are recurring. For example, if
you're at 50% capacity on your present hosting solution, and you're not
growing at 2X a year, I'd encourage a seller to think "Document your
understanding of capacity planning and put it in the kit for the new buyer"
rather than "Move to a +$1k more expensive hosting solution and solve the
scaling problem for the next N years"; that marginal $1k in expenses costs you
$40k~$50k out of pocket.

Several of my buddies in solopreneur SaaSland have sold businesses in the last
year or so. A common thread among many of the sales is waiting too long to
sell. Particularly for those of us with portfolio businesses, an earlier
business which was performing decently but not growing w/o manager attention
often ended up doing the slow decline into that good night thing for 2+ years
prior to finally selling it. This costs both the decline in value of the asset
and, additionally, 2+ years of drag on your ability to give all your business
cycles to businesses which are working well. (I think substantially all of my
similarly situated friends with portfolio businesses would agree that by the
time there were four things in the portfolio it was clear one was a great
recipient of marginal focus and one was not. Substantially everybody held onto
the "not" business longer than they would recommend themselves to have done so
in hindsight.)

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jasonkester
This is by far the most useful, most actionable article to come through here
in months. Hope we see more like this.

My takeaway from the article is that you don't really _ever_ want to sell a
SaaS business if you don't have something more profitable to replace it with.

If you're growing, you'll easily beat a 4X multiplier by simply holding on to
it for a few years. If you're declining or stable, nobody will want to give
you a good price so it's almost not worth selling. The best strategy is to
either keep at it or coast and milk. Worst case, you're declining/stable and
still in the "20-40 hour weeks needed" phase, in which case it might make more
sense to simply abandon the thing.

The only thing that changes the equation is having something else so
successful that those few hours a week spent on your old thing are just a
distraction.

One other thing I notice is that businesses are a lot like houses. If you wait
to fix that weak, drippy shower until right before you sell, the only guy who
benefits is the buyer. If you fix it today, you get to have nice hot powerful
showers every morning from here until you sell. Same with fixing your churn,
documenting & outsourcing your first line support, etc. Fix it today and keep
the profits for yourself, leaving yourself that much stronger when you do
decide to get out.

~~~
nathan_f77
> My takeaway from the article is that you don't really ever want to sell a
> SaaS business if you don't have something more profitable to replace it
> with.

Not really. There's plenty of reasons to sell an illiquid asset, such as a
growing business, or shares in a company. Maybe you want to buy a house, or
you want to put it all in the S&P 500 to be completely passive and have much
lower risk. Maybe you just want to swap your company for a yacht and sail
around the caribbean for a while.

~~~
charlesdm
Most people underestimate how valuable having half a million or so in the
stock market can be. That's true passive income, unlike any business.

~~~
icedchai
Except when the market's dropping everyday, like in '08 or earlier this year.
It takes balls of steel to hold on and keep investing.

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exclusiv
I was offered approx. 4X SDE for my SaaS by a competitor but thought it was
too low.

I felt they should pay even more to get rid of their primary competitor.

I also know what they're up to and their recent strategy benefits their other
business but also benefits mine.

I have a hard to acquire customer but have found a way to connect with
consistent sources to replace most of the churn with a zero cost of
acquisition.

4x was too low for me to pull the trigger. I needed about 8x. Why sell a
business at 4x when it's hard to compete with because the customer acquisition
and churn is a challenge?

The growth fundamentals aren't as good as other businesses but the risk is
much lower. I don't think that is valued enough. Everyone wants to roll the
dice on huge growth when 25-50% annual returns are out there, nearly
guaranteed for small, auto-pilot SaaS companies.

If I sold at 4x and then said, where can I put that money and get a nearly
guaranteed 25% return, I don't think I could find that. That would be risky.

So while 4X may be the upper limit for SaaS valuation metrics like the article
states - it's not going to get the deal done for many SaaS companies. And I'm
fine with that.

~~~
charlesdm
Five years is a long time, a lot can happen in five years.

I've made the mistake of not selling an asset fast enough, and that probably
cost me $100k-150k (easily!). What might look great today might not in two
years.

3-4x does sound reasonable for something that is:

1\. Illiquid

2\. Taxed as income -> less favourably than capital gains on stocks

3\. Requires work, every, single, day

> If I sold at 4x and then said, where can I put that money and get a nearly
> guaranteed 25% return, I don't think I could find that. That would be risky.

Your SaaS business might get hit with a multi million dollar lawsuit tomorrow
and go bankrupt because of it - nothing is certain. But you can definitely get
15-20% returns with proper risk management when investing with your own money.
And if structured properly, those gains are capital gains, meaning you pay (a
lot) less tax.

~~~
ryanwaggoner
_But you can definitely get 15-20% returns with proper risk management when
investing with your own money._

I wish to subscribe to your newsletter.

Seriously, mind sharing some of your secrets for where you're finding these
definite returns of 15-20% with proper risk management?

~~~
charlesdm
As a simple example: the average return of the S&P500 over the last five years
has been 16%.

2010: 14,82% 2011: 2,10% 2012: 15,89% 2013: 32,15% 2014: 13,52% 2015: 1,36%

~~~
ryanwaggoner
That's six years, not five. And the annualized return (geometric mean, not
mean) is 12.85%, not 16%.

Worst of all, you picked a short outlier period to consider. If you instead
look at the trailing ten years of Feb 2006 to Feb 2016, the annualized return
is 6.3%, even with dividend reinvestment. And that's without accounting for
inflation, making your real return closer to 4.5%.

Bump up to look at the last 30 years and with dividend reinvestment and
adjusting for inflation, you get about 7%. I think that's probably a realistic
target to shoot for in the very long run (decades).

Source: [http://dqydj.net/sp-500-return-
calculator/](http://dqydj.net/sp-500-return-calculator/)

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sharemywin
I don't think it's wise to pay more for a business than it's generated in
profits. So, I'm a little skeptically of buying a site that's only been around
18 months and they want 2.5x profit for last years profit plus what the owners
taken out. If it's a fad,trendy, etc or a buy once product(ran out of
customers) or highly dependent on one channel like amazon or google ranking
your taking a pretty big risk. Also, if the owners putting a lot of time in on
the sales and marketing side or operations side and your basically buying a
job.

~~~
jorgecurio
I disagree. you could be buying a SaaS for it's technology which could alone
be worth a lot of development hours and tested code is very valuable imo vs.
rolling out your own.

This of course won't apply to 99% of SaaS which seem to be just CRUD apps
wrapped around bootstrap themes with the vanilla $19/month with a free plan.

The more technically complex a SaaS means the problem it's solving is more
complex. Lack of sales could mean a business or marketing issue.

I wouldn't mind paying $100,000 for a complete SaaS if the product worked as
advertised and the minimum time and development resources needed to replicate
it was very high.

~~~
sharemywin
that's good point too.

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dharmon
This is a good article at covering various business metrics, but I just have
two things to add:

1) Relative valuations can be slippery, and I personally sleep better when I
make an investment I am comfortable with on an absolute basis.

2) Most often, success in investments is more dependent on the accuracy of
your judgment of the business at hand than on your ability to wield
spreadsheets. If you are good at the former, you can be middling at the latter
and do well, but generally not vice versa.

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zephod
My feeling is that a simple revenue multiplier doesn't work as a seed stage
business valuation.

For example, how does this work for pre-revenue SaaS startups valued $1M-$5M
during seed? Even if they've started generating revenue, much of their value
comes from the long-term network effects and potential to create a market
(right?)

~~~
patio11
Seed stage businesses are sold based on the dream of growing into VC-backable
rocket ships; these businesses are sold on being reliable cash machines. If
you're growing at e.g. 20% month-over-month and have $25k MRR, you quite
reasonably will get offered valuations in the high single-digit or low double-
digit millions for the company. (When you attempt to sell 10~20% of it in a
seed round.) The valuation methodology is, essentially, "whatever we can
convince 1+ VCs to accept because they're scared that if they don't say yes a
competitor will." It's far more sensitive to prevailing sentiment in the VC
community and broader tech market than it is sensitive to the exact
particulars of the business being partially sold.

If you're growing at 20% year-over-year, you're basically not investable.
You're totally salable if the business generates a profit; if one were to
throw out $100k per year for that profit (on an SDC basis as discussed in this
post), expect the valuation to be $300k to $400k. This is much, much less
sensitive to the current headlines on Wall Street.

There's a lot of daylight between $400k and $10 million, right? That's the
premium the market places on growth. This is one of the reasons the G word
comes up so much in pg's writing about startups. (See
[http://www.paulgraham.com/growth.html](http://www.paulgraham.com/growth.html)
among many other examples.)

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CamatHN
Great article but I disagree with his multiples.

On average for Fortune500 companies the standard multiple is around 15 times
earnings. x20 or so times for Technology. Granted these likely are the
dominant player and are much more stable but Saas companies have growth
potential that likely exceed such companies.

I think the 4x earnings upper limit is extremely low, especially as there is
likely a reason they are trying to buy you out, not just from keeping it
relatively stagnant in terms of development and collecting profits. I think at
a minimum x10 earnings for a substantial Saas would be the low bar estimation
by me.

Lets be reasonable, otherwise you would just hire someone to maintain and just
cash in if we are talking about a company like this article is talking about.

~~~
ThomasSmale
The multiples we discuss are related to SaaS businesses below $5m valuation.
Fortune 500 companies are indeed valued differently, usually on a multiple of
EBITDA or similar.

10x is very high. Sure, there will be a few deals at that level, but the
majority are not. Our data is based on over 50 SaaS sales below $5m we have
completed so is not just made up or an "estimation". It's where 90% of SaaS
businesses will fall if you want a high degree of certainty when selling.

There are lots of reasons people sell businesses instead of hiring someone to
run them:

\- to reinvest into other growing businesses

\- they are no longer interested in the business (it's not always about money)

\- the business is a mental distraction. Sure, you can hire someone but you
still have to think about that business

\- to benefit from a lump sum of cash now vs waiting 3/4 years, usually at a
lower tax rate (capital gains vs income tax).

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diziet
This applies to projects and businesses run by a couple of individuals, not
startups or fast growing companies.

