SaaS Value Creation is Back-Loaded

One interesting aspect of Software-as-a-Service businesses is that most of the value creation is back-loaded. What I mean is that the majority of the valuation growth occurs in the later years, assuming the startup makes it there and has a rapid growth rate. Here’s an example five year trajectory with amount of recurring revenue and corresponding (hypothetical) valuation:

  • Year 1 – $20,000 annual run rate with a valuation of $2 million (valuation isn’t based on revenue but rather based on the market for a seed-stage SaaS startup)
  • Year 2 – $200,000 annual run rate with a valuation of $4 million (valuation is based on the market for a late seed-stage SaaS startup)
  • Year 3 – $1,000,000 annual run rate with a valuation of $8 million (valuation is based on the market for a Series A SaaS startup)
  • Year 4 – $3,000,000 annual run rate with a valuation of $15 million (valuation based on 5x run-rate)
  • Year 5 – $8,000,000 annual run rate with a valuation of $40 million (valuation based on 5x run-rate)

So, assuming the startup is sold at the end of five years for $40 million, $32 million of that value was created in the last two years and over 50% of the value was created in the final year. In reality, value is created all along, but the premium paid for growth rate (even with modest scale) really emerges at the end as the revenue is ramping up.

What else? What are some more thoughts on the idea that SaaS companies create most of their value at the end before being acquired?

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