SaaS Startup Valuation
The basics in determining valuation for your SaaS company
The software as a service SaaS company growth rate has remained steady across the U.S. Revenue growth in the SaaS market is expected to grow by 17% this year. The total revenue of all private and public SaaS companies is expected to exceed $85 billion. Venture investment in SaaS startups continues to exceed that of most sectors.
As the SaaS business grows, the market is also attracting much of the top talent. This is in large part due to the broad range of applicable solutions. These include security, analytics, accounting, human resources, marketing, and many others. One challenge for private SaaS companies is accurately assessing the value of the business (or valuation).
Potential Investor Valuation
SaaS startups often reach a point where they need significant investment capital to grow. The valuation of a startup is critical in determining the amount of funding that can be raised. A favorable valuation adds to the business’ credibility. Aside from funding, a startup’s valuation may create a perception with potential employees, suppliers, customers, and others.
SaaS company valuation is the foundation of investment negotiations. Independent advisory firms that specialize in valuations may be used. Why is valuation so critical in fundraising? If a startup is offering equity in exchange for capital it is necessary to determine the value of the company.
If an investor is offered a 10% stake in the company they need to know the total value. The same applies if the startup is being sold. Valuations may be based on various factors. They are often considered as “inherently subjective best estimates.”
Early Stage Valuations
Startups that are well-established offer more “tangible” factors that can be used for valuation. The past and current history of performance allow for much more accurate assessments of revenue. In early-stage startups, the methods used for valuation are extremely subjective.
Unlike mature startups, early-stage businesses are likely to have net losses and unpredictable future cash flows. Some factors considered include the potential viability of products, quality of the management team, and the size of their specific market. For this reason, many investors describe this process as being far from an “exact science.”
Late Stage Valuations
More mature startups offer investors a financial history to use for their assessment. This track record allows for a potentially more accurate forecast. There are also considerably more opportunities for evaluating the performance of the management team in mature startups.
Pre-money valuation refers to the value of a business before any capital financing. Post-money valuation is the value after obtaining the financing. Valuations may be intrinsic or market-based.
An intrinsic approach seeks to determine value based on the business’s ability to generate cash flow. In the market value approach, the company’s ability to generate cash flow is not considered. The market value philosophy is based on what those in the market are willing to pay for the business.
Valuation Based on Comparable Companies
The valuation process can be done by comparing a similar company to the one that you are seeking to value. There are a host of valuation multiples that can be used to compare. The enterprise value is a measure of the value of the company that includes any debt. It may be calculated by adding the market values of equity and debt then subtracting cash and related equivalents.
This method is generally seen as the most simplistic. In most cases, this method is used in addition to others. It is generally challenging to find two startups that are similar enough to depend on this method alone.
The Venture Capital Method
This “venture capital” method involves creating some estimates and working backward using some of the following steps:
- The size of the market opportunity is estimated based on the total addressable market (TAM)
- An assumption is then made based on the estimated market share to calculate revenue
- The revenue estimate is then applied to a forecast of estimated costs and profitability
- An earnings multiple is then used to calculate a future exit price
- The future exit value is then divided by the return on investment that is desired to reach a valuation
Valuation Based on Cash Flow
This method is based on a discount rate, which is the rate of return that the investor desires. This rate involves determining the value of future cash flows and then converting it into a present-day dollar value. The company views the discount rate as an estimated cost to finance their business.
In determining the value of a private startup there are many challenges. It requires estimating future monthly revenue, costs, and growth in a particular market. The way that revenue retention relates to churn is critical and specific to SaaS companies.
Retention and Churn
Many critical factors impact SaaS businesses. Retaining customers and the revenue they generate is among the most important. It often takes a large number of resources to secure a new customer.
When a customer is lost, the result is churn. This leads to decreased monthly recurring revenue (MRR) and annual recurring revenue (ARR).
When the company experiences churn, its growth hinges on securing new customers to compensate for the revenue losses. For this reason, emphasis must be placed on the retention of current customers.
Why Consider Revtek Capital?
Startup companies that need capital often must exchange equity in their company for the funding. Revtek Capital offers an alternative model that does not require the borrower to relinquish control. The business does not need to currently be profitable, but it must have recurring revenues that are used as collateral.
The funds are paid back using recurring revenues in manageable monthly payments. Another benefit is that you may be able to receive the funds in as little as four weeks.