Valuation of a SaaS Company: Limitless recurring revenues?
Software-as-a-Service (SaaS) providers are companies that license software on a recurring subscription basis. Customers pay for the subscription with a, usually fixed, monthly or annual fee. Over the last few years, the popularity of subscription based business models and the interest in SaaS companies has increased rapidly, leading to (sometimes) extremely high company valuations.
Whereas traditionally investors prefer to value companies based on a multiple of their EBITDA or profitability using a discounted cashFlow method, recurring revenues seem to be the holy grail for SaaS companies. We have seen the so-called ARR (annualized recurring revenues) multiple leading to astronomically high valuations, even for loss-making businesses. But why? And how can these valuations possibly be explained? If a SaaS company generates €20 million in recurring revenues, but still has a yearly net loss of €1 million, why would an acquirer pay an ARR Multiple of e.g. 1.5x leading to a purchase price of €30 million?
We believe there can only be one logical explanation: future potential. The basic reasoning is that for growing SaaS businesses, net income takes a long time to materialize. Sales and marketing expenses are recognized up front, while revenues from a contractually recurring customer base last many years. This makes new customer contracts unprofitable in the short term, even though they will be profitable over their lifetime.
The larger the potential market, the more opportunities for creating profitable customers over time exists. So instead of looking at (historic) profitability, a strategic buyer of a SaaS company will be much more interested in specific SaaS value drivers including: - TAM: Total Addressable Market (how many clients can it possibly reach?) - LTV: Lifetime Value of customers (how much revenues can it generate per customer over time?) - CAC: Customer acquisition costs (what are the upfront expenses to acquire a new client?) - The overall growth rate of the ARR So here’s something to think about: will the limitless potential for recurring revenues keep driving valuations of SaaS companies to higher levels? Or are investors at some point going to stop paying for potential and start looking for profitable businesses that actually do generate cash from the outset?
By Pedro Mol
AETERNUS MERGERS & ACQUISITIONS EINDHOVEN