Funding Dynamics for Modest Growth SaaS Startups

Continuing with the discussion around SaaS funding valuations and forward multiples, I was talking with a growth equity investor out of the Northeast yesterday and the topic of valuations came up. Now, growth equity typically targets startups with $10 – $25 million in annual recurring revenue and makes a sizable investment ($10+ million). For this particular firm, they focus on SaaS startups with modest growth between 10% and 30% where they believe the companies can continue to grow for a number of years, but are often overlooked by the larger funds because they don’t have a high growth rate (e.g. 60%+ growth per year).

Here’s how they think about these investments:

• Growth rate still drives valuation with typical valuation range being 3 – 5x current annual recurring revenue (but usually closer to 3 – 4x)
• Return expectations are targeted at 3x cash on cash in 3 – 5 years (imagine buying in at 4x run rate, the company doubles in size over a few years, and a buyer comes along that pays a higher multiple)
• Forward multiples are less relevant as there’s not as much competition among investors driving valuations up
• Metrics like gross margins and renewal rates, as well as the management team and market size, also play an important role in valuation

Entrepreneurs looking to raise institutional capital at a large multiple need to have a great growth rate to go with it. Otherwise, the valuations are a much lower multiple of a run rate.

What else? What are some more thoughts on funding dynamics for modest growth SaaS startups?