Private Equity as the SaaS Savior

Several years ago if you were to ask me about SaaS startups and their likely acquirers, I would have rattled off the usual suspects: big software companies that want to get in the space, non software companies that recognize software is eating the world, and the occasional out-of-left-field company that’s making a move. Nowhere on that list is private equity. Now, when people ask who a likely acquirer is for so-and-so startup, private equity is the first thought.

Historically, private equity was known for acquiring profitable companies and either combining them with other similar companies to create more scale or aggressively cutting costs to increase profitability. Regardless, high growth SaaS businesses that burn lots of capital and are rarely profitable in the early years wasn’t the target.

Just in the last few weeks, two high growth Atlanta SaaS startups were recapped (code for new investors coming in and buying out existing investors, ideally at a much higher price than the last round.) The two startups:

  • Gather ($55 million valuation) – Venue management software to manage event spaces and private dining rooms in restaurants.
  • CallRail ($160 million valuation) – Call tracking software for marketers to understand the ROI of different campaigns.

Previously, these types of startups would have raised large growth equity rounds and continued marching towards a massive exit, ideally being acquired by a strategic or going public. Instead, they decided to put money in their pocket (de-risking their position is the lingo) and bring in new partners to help grow the business. And, as part of growing the business, the goal is to make 3-5x their money in 3-5 years, as different from venture capitalists that shoot for 10x+ returns.

When SaaS startups reach modest scale (at least $5-10M+) with a strong growth rate (>80%), private equity firms will compete aggressively to buy the company.

High End SaaS Valuations Using the 2017 Inc. 5000 Data

Every year I love pouring over the Inc. 500 (now Inc. 5000). When I first read Inc. magazine in high school in the late 90s, I made it a personal goal to win the award. As a founder/CEO, I first succeeded with Hannon Hill (#247 on the 2007 Inc. 500) and then with Pardot (#172 on the 2012 Inc. 500). And, now, as a co-founder/chairman, succeeded with Rigor this year (#430 on the 2017 Inc. 500).

When looking through this year’s list, a number of well funded SaaS startups appeared:

  • Gainsight – $23.1M, 3,843% growth, #102
  • Bizible – $3.4M, 2,405% growth, #179
  • Domo – $79.9M, 2,250% growth, #192
  • GuideSpark – $24.8M, 525% growth, #856
  • Smartsheet – $64.3M, 425% growth, #1021

Let’s take Gainsight as it has the highest growth rate and look at some high end SaaS valuations from their funding rounds.

Gainsight Notes

  • Funding rounds listed in Crunchbase:
    • May, 2017 – $52M Series E
    • Nov, 2015 – $50M Series D
    • Oct, 2014 – $25M Series C
    • Nov, 2013 – $20M Series B
  • Recognized revenue by year:
  • Estimated end of year run rate (run rate is always ahead of recognized revenue for fast growing companies):
    • 2016 – $30M
    • 2015 – $17M
    • 2014 – $8.5M
    • 2013 – $3.5M
  • Published valuations:
    • Nov, 2015 – $348M post-money (source)
  • Estimated valuation as a multiple of run rate:
    • Nov, 2015 – $16M run rate with a $298M pre-money valuation making a valuation multiple of 18.6 times run rate
    • Nov, 2013 – $3M run rate with an estimated $80M pre-money valuation making a valuation multiple of 26.7 times run rate

SaaS valuations are typically in the range of 3-5x run rate and can go as high as 10x run rate for the fastest growing startups (see SaaS Funding Valuations Based on a Forward Multiple). When valuations are 18 and 26 times run rate, it’s a bet on building the category winner and a different game compared to 99% of the venture capitalists out there.

Want to explore more? Check out the 2017 Inc. 5000 and Crunchbase.

When Customer Expansion Outpaces Churn

One of the holy grails of successful SaaS businesses is having the expansion of existing customers outweigh customer churn. Meaning, if the business didn’t sign any new customers in a year, the upgrades from existing customers would be more money than the lost revenue from customers that leave, resulting in growth for the company. A business that doesn’t have to sell anything new, but still grows, is in an enviable position.

Here are a few benefits when customer expansion outpaces churn:

  • More Money to Acquire Customers – When customers regularly grow their account, more money can be spent to acquire the initial account, providing additional options for customer acquisition.
  • Faster Growth Rates – The law of large numbers starts to kick in making it hard to grow fast at greater scale. When customer expansion is more than churn, it makes it easier to grow faster as there’s a built-in growth engine.
  • Raising Money – Investors look for unit economics that show the fundamentals of the business are strong, and excellent customer expansion, along with customer renewals, and gross margins are three of the most important metrics making it easier to raise money.

Customer expansion outpacing customer churn is the hallmark of a successful SaaS company.

What else? What are some more thoughts on the importance of customer expansion being larger than customer churn?

SaaS 1,000 for Researching SaaS Startups

Tom Blue and his company published a cool little micro-site today called SaaS 1000. From the site:

The SaaS 1000 is a list of the top SaaS companies according to employee size growth. We have created a simple algorithm that tracks a SaaS company’s 6 month employee size growth and overall employee size to come up with the SaaS 1000 ranking.

One of my recommendations for entrepreneurs researching competitors, prospects, etc. is to go on LinkedIn and check out the respective employee count for the company. This SaaS 1000 list has that data and goes one step further showing the six month employee growth rate, which is great for understanding how fast the business is growing.

For entrepreneurs researching potential business ideas, this is a great way to understand companies that are hiring fast, and thus potential markets to build a competitor.

For entrepreneurs looking for peer groups of other entrepreneurs in their city, this is an excellent starting point (e.g. it lists 25 startups in Atlanta).

Interested in Software-as-a-Service? Check out SaaS 1000.

Build a Competing Company, Internally

Forbes has an excellent article titled Starting Over: How FreshBooks Reinvented Its Online Accounting Service On The Fly. FreshBooks is a popular online accounting app (think major competitor to QuickBooks and Xero, but more focused on micro and small businesses) that’s been around for over 15 years. After 10+ years with the original application, it was clear that the product architecture and user experience wasn’t going to scale for the next 10 years.

We all know that the a full product rewrite is the kiss of death. What to do?

FreshBooks created a separate company, with a separate team, in a separate office, to build a new competitor called BillSpring. BillSpring’s goal was to build a real business with it’s own customer base, that if successful, would replace the original FreshBooks product. After two years, BillSpring was working well and customers loved it. FreshBooks made the BillSpring product the new FreshBooks product while maintaining the legacy product and not forcing customers to switch. Now, FreshBooks has a platform for the future.

Need to reinvent your company? Consider building a competing company, internally.

What else? What are some more thoughts on building a competing company to reinvent the business?

$136,000 Median SaaS Revenue Per Employee

Once the startup begins scaling, leaders from each team start asking for more resources (e.g. we just signed 10 more customers, let’s hire another person to do ‘X’). Only, outside the budget, it’s difficult to assess the overall efficiency. One of the best metrics to track efficiency is revenue per employee.

According to the 2016 Pacific Crest SaaS Company Survey Benchmarks, the median SaaS revenue per employee is $136,000:

Over time, the revenue per employee changes as the startup scales from pre-revenue through to seed stage and beyond. Each milestone often has a higher revenue per employee with ones at the expansion stage typically having $200,000 or more in revenue per employee.

Entrepreneurs would do well to track their own revenue per employee and benchmark it against other startups of similar size and scale.

What else? What are some more thoughts on using revenue per employee to evaluate the efficiency of the startup?

4 Criteria for a 5-8x Adjusted EBITDA Software Exit

Upland Software is a publicly-traded SaaS company based in Austin, TX that specializes in acquiring sub-scale SaaS companies and rolling them into the portfolio. To date, they’ve acquired 14 companies and are actively looking to buy more. With a market cap of $480 million and an annualized run-rate of $80 million (source UPLD), they’ve executed this strategy for 7+ years.

Here are the four criteria for Upland Software acquisitions:

  • Financial Profile – Revenues in the $5-$25 million range
  • Recurring Revenue Base – Renewal Rates > 90%
  • Enterprise Applications – Built-for-purpose Enterprise Work Management
  • Geography – U.S., Canada and E.U.

According to their press release from a few months ago they pay 5-8x pro forma Adjusted EBITDA:

The acquisition is within Upland’s target range of 5-8x pro forma Adjusted EBITDA and will be immediately accretive to Upland’s Adjusted EBITDA per share.

Long term, their target is an Adjusted EBITDA margin of 40%.

Here’s how an acquisition might work:

  • $10 million/year SaaS business makes $3 million/year Adjusted EBITDA
  • Upland acquires the SaaS company for $21 million (e.g. 7x Adjusted EBITDA)
  • Upland cuts expenses and raises the Adjusted EBITDA from $3 million to $4 million (e.g. 40% target)
  • Upland’s stock trades at ~18x Adjusted EBITDA (e.g. $26 million Adjusted EBITDA expectation for 2017 with a valuation of $480 million ignoring current assets and debt – source)
  • $4 million of new Adjusted EBITDA increases the value of the business by $72 million, making the $21 million acquisition very profitable

Entrepreneurs thinking through potential exit value for their startup should understand these values and how a financial buyer might value the business.

What else? What are some more thoughts on this example with four criteria for a 5-8x Adjusted EBITDA software exit?