Business valuation tends to be a complex process, but an established business can provide an important starting point. A valuation expert will look at the company financials and metrics for comparable businesses (where available) and determine which of the three classic valuation approaches—market, cost, or income—is most appropriate to apply.
Software as a service (SaaS) company valuations are a horse of a different color. Because so many SaaS companies are startups without much in the way of income history, valuation specialists must often adjust their approach. In this article, we’ll examine different ways an appraiser can perform SaaS company valuations.
For SaaS companies that have adequate revenue history, most are valued using a multiple of seller discretionary cash flow (SDE, typically used in valuations for small businesses with less than $5 million in annual revenue) or a multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA). The formula for SDE is:
SDE = Revenue + owner compensation – cost of goods sold – operating expenses |
SDE represents the profit left to the business owner after all costs of goods sold and essential operating expenses are deducted from the gross income; it represents the true earning power of the business. EBITDA represents the same thing for larger businesses. Once the SDE or EBITDA is established, SaaS valuation multiples are applied to determine the value of the business.
The determination of the appropriate multiple to use is the most difficult part of the process. There are a number of variables to consider when determining the multiple; the following are the most common:
These are the primary factors that will determine the multiple used to establish the company’s value in SDE- and EBITDA-based valuations. SaaS valuation multiples range from four (for low revenue, young companies with high owner involvement, flat growth, and high churn) to 10 (for higher revenue, more established companies less reliant on owner involvement with growing revenues and low churn).
For startup SaaS companies, valuations are trickier. New startups typically have limited revenue history, making it challenging to establish a value.
One approach is to value the opportunity cost of purchasing the SaaS business versus investing the same amount elsewhere. Depending on revenue and multiples, the company may not be worth much when valued using this approach.
Another option is to use a Monte Carlo simulation. In the Monte Carlo model, simulations are run on a wide range of revenue possibilities to predict probable outcomes; once simulations are run, a pattern begins to emerge. The scenarios and probabilities can be transformed to a statistical approach that can be used in a discounted cash flow analysis.
Ultimately, for startup SaaS company valuations, the safest route is to use multiple models, dig deeper into the specifics of the market and competitors, and use caution in making assumptions. The general assumptions for more established companies don’t apply. The range of factors at play in SaaS company valuations, combined with the difficulty in valuing startups, makes value much harder to establish and more subject to the validity of assumptions made in the valuation process.
Valentiam has helped companies in a variety of industries attain accurate enterprise and asset valuations. We have extensive experience in the application of all valuation methods for a broad range of businesses and situations. Our valuation and transfer pricing specialists have worked with some of the largest companies in the world.
Contact us to see how we can help your company with your valuation and transfer pricing needs.