SaaS business valuations have many variables. We’re here to talk you through how SaaS companies get valued, important SaaS metrics you need to know, other factors to consider during valuation, and how to increase the value of your SaaS business.
Every SaaS business and company is driven by growth, both in size and revenue generation. Sure, some other factors and metrics come into play. Still, the significant increase in revenue and profit since the inception of the SaaS company is a primary variable that determines the current and future worth of the company. The same applies to your SaaS company as well.
As a result, it is important to be aware of your company’s growth margin daily. This gives you an insight into your SaaS business valuation. It also helps you gather data on what affects your company’s growth or undergrowth and predict what would happen after every major and minor decision regarding your business.
Knowing your SaaS company’s worth in the market allows you to get familiar with its growth trends, both the ups and the downs, and prevents surprises by keeping it controlled by internal and external factors.
How Do Companies Get Valued?
It is one thing to be aware of your company’s worth in the market; it is another to know how to evaluate your SaaS company. SaaS valuation is an essential and complicated criterion critical to all SaaS companies, including start-ups.
Your SaaS valuation convinces your investors that your business is worth their investment risk. They want to know its present and possible future value and whether your company can balance its risk with profits as rewards.
Your SaaS company can be valuated in 3 general ways. Depending on your business maturity, business model type, and value proposition, you can pick any of the three methods that cater to your criterion the best. The valuation methods are Seller Discretionary Earnings (SDE), Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA), and Revenue.
Seller Discretionary Earnings (SDE):
Start-up businesses mostly use SDE, which is operated by the owner alone. As a result, the owner will usually pay himself outside the market range and also pay for personal items unrelated to the business to reduce high tax.
In this case, SDE calculates the total revenue of the business minus the cost of goods sold and other essential operating expenses. The owner’s salary and other personal expenses can be added to the resulting profit after deductions.
SDE = Total revenue generated – (Cost of goods sold + Essential operating expenses)
These businesses are steadily growing and are usually in their initial stages. So, SDE is used for companies like them that are less than $5,000,000 in value.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA):
This valuation method is used for large, growing SaaS businesses with more than $5,000,000 in value. These SaaS businesses have more employees, and the ownership management is shared amongst shareholders and investors of the company, i.e., it is not one-person business management.
To calculate the SaaS value for these businesses, the total revenue generated before any deductions would be considered.
EBITDA = Total revenue generated + Interest +Taxes + Depreciation + Amortization
Every expense, both discretionary and non-discretionary, would be added to calculate the value of the SaaS business.
This valuation method is based on the Annual Recurring Revenue (ARR) generated by the SaaS business.
This valuation method is usually not considered by most SaaS companies but is also effective in SaaS company valuation.
To calculate valuation using this method, the companies must earn close to 1 to 100 million dollars per ARR, or within that range.
SaaS Metrics That Matter
There is no known methodology to watch out for when you want to valuate your SaaS company properly. Even using Key Performance Indicators (KPI) as a preferred method to valuate your company will most likely result in misappropriation of value, as stated in a Forbes finance blog.
However, there are certain SaaS Metrics that you need to monitor and note to at least get the hang of how your SaaS company is valued in the market. These metrics include:
The Rule of 40:
A known SaaS Metric in the SaaS space is the rule of 40. This rule encourages all SaaS companies to work towards achieving a growth rate and a profit margin of 40% or more than that.
This high-profit margin ratio would undoubtedly increase the value of your business in the face of investors and the market. It would continue to bring more money to further the business growth.
Net Dollar Retention:
The net dollar retention helps you to analyze and group your customers according to the period and service they signed up for with a corresponding reference to how consistent they are with payment throughout their use of your service.
This will help you measure if they order a decrease or increase in the price of services as compared to their original sign-up payment, and it is usually measured in percentage.
So, the original value would be recorded as 100%. If there is a 25% increase in service payment for a month, the amount recorded for that long would be 125%, and a 25% decrease would be 75%.
The growth rate of your company over the years is also an important metric that helps you place value on your SaaS company. Investors are more likely to invest in companies that have a steady or rapid growth rate so that they make profits from your business. The more the growth and profit margin, the more it is valued in the market.
Your company’s ability to retain customers is more critical than gaining new ones. Your customers’ churn rate must be low to retain as many as possible. Loyal customers will generate revenue for the business during highs and lows.
Your customer retention rate is also an important metric that helps increase your company’s value.
The annual recurring revenue that your business generates would highly determine your stand in the market. This metric also depends on your customer retention rate. The number of customers that you’ve retained would contribute to the recurring revenue that you generate for your business annually.
It is also essential to consider ways to increase your ARR, which will, in turn, increase your SaaS company’s value.
Increase the Value of your SaaS Business
One of the most critical ways to increase the value of your SaaS business is to learn how to increase your customer retention and reduce their churn rate. To do so, however, you need to meet their needs, as Neil Patel mentioned, as your services promise.
But most importantly, you need to stay ahead by constantly calculating and valuating your SaaS company to see how your decisions affect how the company is fairing in the market. Intrepid Finance has easily accessible financial calculators to make this task a reality that’s easily grasped.
We are financial experts, and with the help of our financial calculators, we can help you calculate how much your monthly or annual recurring revenue is, which gives you an insight into what your SaaS business is worth.