When thinking of Software-as-a-Service (SaaS), one of the first things that comes to mind is the quality of the business model. With almost all recurring revenue, high gross margins, great renewal rates (ideally), and strong market adoption, it really is one of the best models across all types of business. Due to the confluence of factors like quality of business model, hype in domestic public equities, and desire for growth, SaaS companies are currently receiving extraordinary valuations. While I don’t believe 10x+ revenue valuations are sustainable, I do believe we’ll see 4 – 6x revenue valuations indefinitely, assuming 30%+ revenue growth rates (otherwise valuations will quickly drop to 2 – 3x revenue).
Here are a few valuation drivers for SaaS companies:
- Growth Rate – this is the most important factor and I calculated growth rate to be a 2.5x multiplier for valuation
- Market Opportunity – the bigger the better (one of the reasons Workday – NYSE:WDAY – gets such a big premium, in addition to growth rate)
- Up-sell / Cross-sell Potential – the more complementary the better (one of the reasons Pardot was so valuable to ExactTarget / Salesforce.com)
- Scale – hitting $10M in revenue really opens things up for larger acquirers and hitting $50M+ in revenue opens things up for an IPO (more options creates more leverage)
- Renewal Rates – 90%+ is the target (some have greater than 100% revenue renewals because they expand the account size in existing customer accounts), but watch out for leaky buckets
- Gross Margins – 80%+ is desirable but some SaaS companies have weaker gross margins due to more services work, unusually high on-boarding costs, or other expenses (e.g. third-party fees or licenses)
SaaS startups, like all companies, should optimize for the needs of the customer and not maximum valuation, but it’s useful to keep these in mind when building the business.
What else? What are some other valuation drivers for SaaS startups?