Selling your SaaS startup is an exciting step forward in your company’s journey, but you’ll need a proper valuation of your business before you can seal the deal. Getting a valuation early in the sales process can give you a leg up when you sell your startup. Your valuation is a key piece of information that buyers will need before moving forward, and it’s important to get it right.
There isn’t one clear-cut method for determining the value of your startup. Finding the right number is a delicate balance. Overvalue yourself and potential buyers won’t even consider you, but you don’t want to sell yourself short by undervaluing either. In this article, we’ll talk about the different factors to consider when valuing your SaaS startup.
Finding Your Multiplier
Before you decide what formula to use when valuing your startup, you’ll need to determine which multiplier to use. All valuation calculations use a multiplier – this could anywhere between 3x and 15x your annual earnings or revenue, although most SaaS companies land in the 5x to 10x range. There are many different factors that can affect your multiplier.
Considering the multipliers that similar SaaS companies have used recently can give you a good place to start. Platforms like Crunchbase, AngelList, and even LinkedIn are full of helpful information about startups that have already sold and how they got there – including SaaS startups. However, this shouldn’t be the only thing you consider when determining your multiplier, as every company is different. Even your most direct competitor may have a different multiplier or overall valuation due to the nuances of their business. It’s also important to remember that public companies are going to be valued at a higher level than private startups.
You’ll want to start by looking at your annual revenue as well as your own year-over-year growth and growth in your industry as a whole. Companies with a higher annual revenue and stronger growth metrics are going to have higher multipliers. Beyond that, here are some of the other factors to consider when determining your multiplier. Ultimately, your multiplier is a reflection of your company’s potential for ongoing stability and success.
Lifetime Customer Value
This number is the average revenue a customer generates over the course of all their purchases from your company. Companies whose customer bases tend to make repeat purchases or very large purchases are going to have a higher lifetime customer value than companies with customers who only make one-time purchases. Lifetime customer value is particularly important for SaaS startups because they focus on building a consistent, recurring customer base.
The churn rate is another key metric to factor into your multiplier. Your churn rate is the rate of customers you lose. Ideally, your company will want to have a low or even a negative churn rate. This indicates to potential buyers that your company can retain customers in the long term.
Customer Acquisition Cost
The customer acquisition cost is the total amount of money your company spends to acquire new customers. This includes the cost of marketing and sales as well as the labor and technology costs to onboard new customers. High customer acquisition costs can make it difficult for your company to scale long-term, while low customer acquisition costs can make growth easier and more streamlined.
Beyond these three key metrics, there are a myriad of other factors that SaaS startups should consider when determining their multiplier. For example, you’ll need to consider the age of your company and the pace of growth you’ve experienced during that time.
Additionally, you’ll need to consider your total addressable market – is there room in the market for your business to continue expanding? How much competition are you currently facing? Does your business model allow you to pursue multiple streams of revenue or pivot in the future? These are all factors that potential buyers will be thinking about, and they should be factored into your multiplier to create a more accurate valuation.
There isn’t one “right” way to find the best multiplier for your startup, as these factors are very nuanced. If you’re struggling to determine a multiplier, it can help to get a third-party opinion. Consider searching for a mentor or coach within the SaaS startup space that can provide guidance that is specific to your company.
Calculating Your Valuation
Once you’ve determined what your multiplier is, there are a few different equations you can use to calculate your total valuation. The right equation for your company will depend on your company’s business model and history thus far. Here are the most common models that startups use to calculate their valuations.
An SDE-based valuation is going to be appropriate for most small businesses in the SaaS space. SDE stands for Seller Discretionary Earnings and works very well for small businesses with one owner. To calculate your SDE, you will subtract your operating expenses and your cost of goods from your total revenue. Then, you’ll add your total owner’s compensation back into the metric to get your SDE. From there, you’ll take your SDE and multiply it by the multiplier figure that you’ve already determined to get your valuation.
For larger SaaS startups, an EBTIDA valuation is often more appropriate than an SDE valuation. This is because an SDE valuation adds owner’s compensation back in, but once you build a larger team with more stakeholders, this value is no longer the most accurate measure of your financial success.
EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. There are two different ways to calculate EBITDA, depending on what makes the most sense for your company. You can start with your operating profit and then add depreciation and amortization, or add together net profit, interest, taxes, and depreciation and amortization. Both calculations are widely accepted, but you will need to pick once and stick with it. Once you’ve publicly decided how you want to value your company, you can’t switch back and forth between these calculations.
Once you have your EBITDA number, you will multiply that by the multiplier we’ve discussed in the previous section to get your total valuation. This calculation typically works well for companies with high profit margins. Even if your revenue numbers are relatively low, the EBITDA valuation will account for profit to provide a more accurate representation of your company’s value.
There are situations where neither an SDE calculation nor an EBITDA calculation makes sense for your business. Many SaaS companies aren’t profitable in the early stages of operation because they need to invest aggressively in growth. This is an accepted practice, but if this is the case for your business, your SDE or EBITDA calculations are going to come out to zero.
In this case, you can calculate your company’s value using revenue. This provides a more accurate picture of your company’s value, as many of your current growth-related expenses are temporary. In this case, you can apply your predetermined multiple directly to your revenue numbers to determine your valuation.
Because there are so many different ways to determine your SaaS startup valuation, you’ll need to be very thoughtful to determine which approach is right for you. You’ll also need to make sure you can back up your valuation with a strong business model, growth projections, and more. Anyone can say their company is valuable, but buyers will expect evidence to back that up before closing the deal.
There are also steps you can take from the beginning of your company to increase your valuation and set yourself up for success. Document all of your internal processes and make sure to protect your intellectual property – this keeps the value of your product high. You’ll also want to have a forward-thinking pricing plan to ensure your company can continue to make money as the economy changes. On top of that, it can be very helpful to consider other addressable markets, acquisition channels, and streams of revenue that you could pursue in the future, and document the strategies you would use to break into these markets.
Buyers will require a valuation before making a deal, but it is in your best interests to know what your company is worth well before you think about selling. Having a rough valuation in mind early on can help you make the right choices as your business grows and changes.
Andrew Gazdecki is a 4x founder with 3x exits, former CRO, and founder of MicroAcquire. Gazdecki has been featured in The New York Times, Forbes, Wall Street Journal, and Entrepreneur Magazine, as well as prominent industry blogs such as Axios, TechCrunch and VentureBeat.