Valuation is one of the favorite topics of conversation when it comes to Software-as-a-Service (SaaS) companies. While normal companies might be valued at 4-6x their profits, unprofitable fast-growing SaaS companies are often valued at upwards of 10-14x revenue (e.g. see ChannelAdvisor trading north of 12x revenue net of cash on hand). Jason Lemkin, a partner at Storm Ventures, highlights a number of solid reasons why SaaS isn’t a bubble, even if it’s overvalued.
Here are a few reasons why people are paying a premium for SaaS companies:
- Generational shifts are taking place within the software industry where everything is moving online, and the vast majority still isn’t web enabled
- Few companies are growing fast, let alone experiencing hyper growth with no signs of slowing down
- Subscription (recurring) revenue combined with strong gross margins and high renewal rates results in one of the best business models anywhere
- Opportunities to consolidate competitors and create more economies of scale abound
- Most SaaS companies spend a disproportionate amount of revenue on sales and marketing to fuel growth, and can turn it off (with some pain) such that they’d become extremely profitable
While I believe SaaS companies are overvalued due to a lack of growth companies in general, there’s still tremendous growth ahead that bodes well for the sector. With strong growth rates and renewal rates, SaaS companies are going to get a premium over their peers.
What else? What are some other thoughts on SaaS company valuation premiums?