SaaS companies, like the other sectors too, are worth the present value of their estimated future cash flow.
By Päivi Kangasmäki
Compared to product business, SaaS is the winner takes it all -business. SaaS business valuation is different, because the revenue for the service comes over an extended period, the customer lifetime. Sales and marketing expenses are recognised up front, while revenue lasts many years. This is why SaaS business valuation model depends on the company’s growth stage.
For SaaS business, the best estimate of future cash-flow is recurring revenue (ARR or MRR). And it’s not only revenue but the month over month growth in revenue. Revenue growth is more than twice as important for determining valuation multiple.
Traditional product business focuses on EBITDA. This is also a good metrics for SaaS business, which has been reached a certain growth level but it does not show the progress well in the early growth company. Additionally, many SaaS companies capitalise their development costs and this improves EBITDA significantly. Instead of EBITDA, more valuable for a SaaS startup would be to track monthly customer acquisition costs and customer lifetime value development because those enable to track long-term direction based on the monthly development.
So, You want to maximise SaaS growth?
So, whether you’re currently seeing investors or not, growth is still your primary concern. If you are SaaS entrepreneur and want to maximise your valuation, focus on three things:
1.Focus on maximising monthly MRR and minimise monthly Churn
Monthly Recurring Revenue spots the subscriptions each month. It’s the most important SaaS metrics of all. Make sure you’re doing it right – I’ve seen several companies tracking this directly from revenue of fixed-period-billing, both wrong. You can track this against your monthly revenue, but keep MRR calculation in your hands (or software). If your rate of new customer acquisition (MRR) exceeds the churn rate, your SaaS business will grow! So easy.
+ New subscriptions per month per customer
+ Churned subscriptions per month per customer
+ Upselling subscriptions per month per customer
MRR does not include:
- Setup fees or one-off fees
- consultancy fees or any non-recurring fees
- Credit adjustments or credit notes
Churn rate is the amount of customers or subscribers who cut with service during a given time period. Note that Churn is growth decelerator and it impacts negatively on your MRR and your valuation. A high churn rate always signals a problem. In that case, focus on solving the issue before getting new subscriptions. If your rate of new customer acquisition (MRR) exceeds the churn rate, your SaaS business will grow.
2.You’re there! Your Customer lifetime value is higher than the cost of acquiring a customer
This is the golden rule for any SaaS entrepreneur looking for growth. This tells you when to turn on the engine of growth.
When your customer lifetime value is several times higher than your customer acquisition cost: you’re there!
Lifetime is value is important for SaaS business which is based on subscriptions. Lifetime value shows how much revenue you could expect per customer during the entire future relationship which can include several subscription periods. When you know the value, it helps you establish how much money you could spend to acquire a new customer. Simple as that.
Customer acquisition is one the biggest expenses for SaaS companies. You can calculate CAC by adding up all your monthly marketing and sales related expenses. And then dividing that number by the number of new customers.
Your historical growth rate is the single biggest driver of valuation multiple, and it’s compared to the similarly-sized peers. The upper limit of the growth will be your total addressable and obtainable market size, which is the most strategic question for you. As you’ve been decided to belong to the 1$ billion Market Cap Club in some nice day, it’s good to start to track your metrics as early as possible. That track will be your greatest guide in your and your investors next year’s journey.