Valuing any business is part art and part science and the market for SAAS businesses is no different. Only by having a focus on a particular industry and a particular range of the market can any investment banker or broker have an accurate pulse on the market and an accurate understanding of what a certain software business will sell for. For that reason, we recommend to use calculators (including our own) as nothing more than a guideline.
Unlike many other industries trading in the mid-market, software businesses have proven to be very liquid. Because of their passive operating nature and low overhead, private equity companies, family offices and other industry buyers have a voracious appetite for them.
Software (SAAS) Valuation Calculator
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Software (SAAS) Traits & Appeal to Buyers
The golden nugget for software investors is a business that has all of the following factors:
- Residual customers (less than 10% churn)
- Customers are businesses (B2B)
- Low competition in niche
- Very few customer service tickets. Ideally these could be automated by having a FAQ & help section or employees in place to handle them.
- 5+ years old
- Growing at 10% percent annually
Software (SAAS) Deal Structures
Because financing is so tough to come by for digital business acquisitions, buyers try to mitigate as much risk as possible by asking buyers to hold a seller’s note or including an earnout in the purchase structure. The more flexible the seller is on deal terms, the more buyers the business appeals to.
Generally, the buyers will try to hedge their risk by having the seller hold a note with certain criteria that needs to be met by the business. An example of this transaction structure is:
- $800K paid at close
- $600K paid annually for 3 years. (3 X $200K payments)
- In order for each of these payments to be made, the business must maintain X% of it’s customers.
Valuation Growth By Revenue Increase
As the MRR range of SAAS businesses increases, the number of interested parties decreases. However, the buyer’s that are interested are typically much more serious and have more money to spend.
Software is a favorite sector for search funds, family offices and other portfolio companies. The recurring revenue and high gross margins make them appetizing. However, these buyers that raise capital are really only looking for SAAS with $5M + ARR and a low churn rate. It is not uncommon for businesses that meet this criteria to sell for 5-6 X EBITDA. These investment firms will also consider “bolt-on acquisitions” that are between $2M-$5M in ARR. A bolt-on acquisition is a business that has synergies with a company that they are already running and they can run the two businesses as one. These deals will often sell for 3.5-5 X EBITDA. You can read more about bolt-on deals here.
For businesses under $1M in ARR, your business can still be sold, but it may be to a different buyer. A career changer from the tech world, an engineer seeking more freedom, a small partnership that buys small SAAS businesses that they believe they can scale through great marketing. If your business has a track record or recurring profitability, there will be buyers that are willing and able to purchase it. SAAS businesses under $1M in ARR typically sell for 2.5-3.5 X EBITDA.