Valuation depends on the purpose

Entrepreneurs often ask me, “What do you think about the valuation of our Software-as-a-service (SaaS) company? We are growing triple digits each year, and we think our company is worth X million, but venture capitalists are calling us crazy.” Each time, I tell them that there is no holy grail for calculating the value of a company. The old saying that company valuation is more of an art than a science is especially true when it comes to valuing a SaaS company.

A valuation typically depends on the purpose and the person performing the valuation. For example, an M&A advisor working on a sell-side project is most likely trying to maximize the valuation of the client’s company, which doesn’t mean that the company is always sold to the highest bidder (maximizing the valuation can be due to other factors, such as synergies with other companies who offered a lower valuation). A venture capital investor who is willing to invest in a company often wants the lowest valuation possible, since that way he will get the most number of shares for his money. In my opinion, this means there is not one “true” value when it comes to a valuation.

Methods to value fast-growing SaaS companies

Having this knowledge in the back of our minds, I will provide a couple of examples that can help you to value your own SaaS company. When you do a Google search for “valuation methods of a company”, chances are you will come across the most common methods for valuing companies, such as discounted cash flow (DCF) analysis and comparable companies or transaction multiple analyses. It is widely recognized that these techniques are not appropriate for valuing start-ups and scale-ups. This is because DCF analysis is typical used for mature companies with stable cash flows, while start-ups often have negative cash flows, so a DCF analysis doesn’t make sense. Multiple analysis can also be a tricky method, because often transaction multiples are not disclosed and the method assumes that companies are similar to each other in some way, when in reality every company is always different.

So what methods can you apply to your SaaS company? What follows are three different methods that can be useful.

  • SaaS Valuation Growth Rate Multiplier
  • 80 – 110x MRR
  • Revenue growth multiple 5 years

 

Method 1: SaaS Valuation Growth Rate Multiplier

As explained by David Cummings, see this link

Assumptions: the gross margins are in the 70-80% region with renewal rates in the 80-90% range

Valuation = ARR + (3*(GRM+GR))

Whereby

  • ARR: Annual Recurring Revenue
  • GRM = Growth Rate Multiplier = 2.5
  • GR = Growth Rate

 

Method 2: 80x – 110x MRR (Monthly Recurring Revenue)

The 80x – 110x MRR can be considered sort of a rule of thumb, as mentioned by Christoph Janz of Point Nine Capital.

Valuation range = 80-110x * MRR

Method 3: Revenue growth multiple 5 years

This method basically says the value of the company is equal to the expected growth over a five year period time, described by Scale Venture Partners

Valuation = Revenue * expected 5 year revenue growth (incl. discount)

Example valuation

Let’s assume at the end of December 2016 that a company has grown from $480K ARR at the start of the year to $1M ARR (108% growth YOY). Let’s also assume that the company will grow to some $10M ARR in the next five years. By applying the different valuation methods we come to the following overview.

Method Valuation
SaaS Valuation Growth Rate Multiplier $ 5.7M
Valuation at 80x MRR

Valuation at 110x MRR

$ 6.7M

$ 9.2M

10x revenue growth in 5 years w/ 25% discount $ 7.5M
Average $ 7.3M
Low / High $ 5.7M – $ 9.2M           

 

Based on the above valuation method, the company’s valuation is estimated between $5.7M and $9.2M. This can give you a rough idea of how much your SaaS company is worth, based purely on the financials.

Caveat

In reality, however, and here is the caveat, investors look at all aspects of your company, and ask themselves the following questions (non-exhaustive list):

  • Do we believe in your product or service?
  • How robust and scalable is the business model?
  • How sustainable is the growth?
  • What is your forecast for the coming three years?
  • How do the KPI metrics evolve over time?
  • How big is the market and what is the potential?
  • Do we believe in the team?
  • Does the team has a proven track record?
  • What about the competition?
  • How can we add value?
  • What are potential exits?

So, when you combine all the factors together with a compelling story, you have a strong basis for negotiations with well-thought-out arguments. I cover these things in more depth in my post “How Do I Create a Compelling Pitch Deck That Increases My Chances With Investors?

Disclaimer: Opinions expressed are solely my own and do not express the views or opinions of my past and future employers, clients or any party related