When talking to SaaS entrepreneurs, inevitably the topic of valuations come up. Right now, public SaaS companies are trading at all-time highs, so entrepreneurs expect those valuations to apply to their startups. While the valuations of public and private SaaS companies have a direct correlation, it’s important to understand that not all SaaS revenue is created equally, regardless of public or private markets, thus valuations as a function of revenue vary wildly.
As expected, premium SaaS valuations are driven by premium SaaS metrics. Here are a few of the most important ones:
- Annual Recurring Revenue – The annual run-rate is the most talked about SaaS metric. Ensure that it’s contracted, recurring revenue as different from other revenue sources like services revenue and payment processing revenue.
- Gross Margin – The money left after the cost of goods sold are taken out. SaaS company gross margins vary dramatically from the low 60s to the high 90s. Anything below 60% gross margins isn’t SaaS (startups masquerade as SaaS but often aren’t). A SaaS company with 90% gross margins is 50% better than a SaaS company with 60% gross margin, and correspondingly much more valuable per dollar of revenue.
- Growth Rate – The year-over-year growth rate reflects the potential to continue growing fast, and ultimately achieve a much greater scale in the business. Investors pay a huge premium for high growth.
- Net Renewal Rate (also Net Revenue Retention) – The gross renewal rate plus upsells and cross-sells represents how the annual recurring revenue will change assuming no new sales. Investors pay a huge premium for high net renewal rates.
Directionally, the simplest formula for SaaS valuations is as follows:
- 10 x
- Annual recurring revenue x
- Growth rate x
- Net renewal rate =
- Valuation
Here’s a quick example:
- 10 x
- $5 million in annual recurring revenue x
- 50% growth rate x
- 105% net renewal rate =
- 10 x $5,000,000 x .5 x 1.05 = $26,250,000
So, a $5M SaaS company with good growth and good net renewal rates would be worth a bit more than five times annual run rate.
To make it more complete, you’d add in gross margin and elements to reflect more nuanced variables like the potential size of the market (e.g. a valuation premium for bigger markets).
One SaaS company might be worth 15x run-rate (due to high growth rate and high net renewal rate) while the next one might be worth 2x run-rate (due to no growth and high churn).
Premium SaaS metrics are required for premium valuations. Look at the entire picture, not just annual recurring revenue.
David Cummings on Startups 
Is a 10x multiplier pretty standard here? What factors would be a cause for changer there?
The 10x multiplier is just a short cut to make the math for the other percentage multipliers easier e.g. a 50% growth rate is roughly worth 5x revenue, so 10 x revenue x .50 is the equivalent.
Makes sense, thank you!
This was incredibly helpful. Thank you
Great piece!
One thing I’ve seen distinction around is new business growth rate vs. raw revenue growth rate.
So new customers vs expansion revenue. The former gets more weight.
On Sat, Jan 18, 2020 at 15:55 David Cummings on Startups wrote:
> David Cummings posted: “When talking to SaaS entrepreneurs, inevitably the > topic of valuations come up. Right now, public SaaS companies are trading > at all-time highs, so entrepreneurs expect those valuations to apply to > their startups. While the valuations of public and private” >
Thanks for posting this. One comment: In a devops world, there is a strong argument that the devops team in a saas company belongs above the gross margin line. The advantage is just better cost accountability – instead of managing R&D as a % of opex it is directly tied to the product. Under your valuation method, a company doing that would be worth less money, even though I would argue that it is actually a better managed company.
Great article. I’ve done similar rough math around valuations comparing companies, but never tried to make it formulaic and repeatable. I was also trying to take in to account GM. Maybe * (GM/75%) to provide premium for above average GM and haircut for lower GM. Thoughts?