Continuing with last week’s post on 3 Quick Ideas When Thinking about SaaS Valuations, there’s another common way to determine a SaaS valuation for funding purposes based on a multiple of what the revenue or run-rate will be in 12 months. This approach is known as a “forward multiple”, and because the valuation is based on an expected amount in the future, it effectively takes into account the current growth rate, which is one of the largest, if not the largest, drivers of valuation, everything else being constant.
Long term, SaaS companies will likely trade at 4-6x revenue based on strong recurring revenue, great gross margins, and excellent economies of scale. As a simple example, if a SaaS company was put into harvest mode, it could generate 60-80% profit margins and get an EBITDA multiple of 6 – 10x, resulting in the same value as 4-6x revenue.
So, if a startup is doubling year over year, and expects to double again next year, a funding valuation could be 4-6x the expected run-rate in twelve months. If a startup is at $5 million today, and will clearly be at $10 million in 12 months, asking for a pre-money valuation of $40 – $60 million might get funded, assuming a great team and market. Investors would be willing to “pay up” for a fast-growing startup as they believe it’ll continuing growing fast and has the opportunity to be a large, meaningful business.
For entrepreneurs raising money, use the idea of a forward multiple when discussing valuation.
What else? What are some more thoughts on SaaS funding valuations based on a forward multiple?