How to Value & Sell a SaaS Company
With the explosion in SaaS M&A activity over the last 12-15 years, there is now a reliable body of knowledge on how to value and sell a SaaS company. In this guide, we explore the key factors that go into both activities.
This report is the result of dozens of interviews with SaaS entrepreneurs conducted by our research team between 2019 and 2023. In addition, we sourced data on current valuation multiples from 20+ third-party M&A databases between June 2022 and May 2023 (see sources).
How to Value A SaaS Company
As with home valuations, SaaS company valuations are a reflection of the current market and each individual buyer’s degree of motivation. While there are established practices for valuing SaaS businesses, selling it is a far more creative and emotion-driven process. Thus, the first section of this report focuses exclusively on the quantitative metrics that go into a SaaS company valuation, while the second discusses the comparatively qualitative process of selling a SaaS business.
SaaS Valuation Methodology
There are three broad areas that prospective buyers of a SaaS company – typically, either strategic buyers or private equity companies – consider when valuing the business:
- Financial Information: Your company’s revenue (typically expressed as ARR), profitability, and cash flow
- Customer Metrics: Your customer base’s size, lifetime value, retention rate, acquisition cost, and satisfaction levels
- Market Trends: The trends of the current market, both in a macro sense and within your company’s niche or vertical
SaaS Valuation Models
In M&A, companies are valued using a multiple of a key financial metric. The two most common metrics used to determine price for a SaaS business are:
- ARR – The company’s annual recurring revenue
- EBITDA – The company’s earnings before interest, taxation, depreciation, and amortization; basically the same as operating cash flow, except it takes interest and taxes into account.
While EBITDA is the industry standard in non-SaaS M&A, ARR is the most common metric in SaaS M&A. However, both valuation models can be better suited for specific situations, as described below.
The ARR vs. EBITDA Valuation Models for SaaS
|Annual Recurring Revenue (ARR)||EBITDA|
|Formula||ARR = Average Annual Profit/ Average Investment||EBITDA = Net income + Interest + Taxes + Depreciation + Amortization|
|Pros||Demonstrates capacity for growth||Demonstrates profitability|
|Indicates potential for profitability if proper operational practices are implemented||Gives a truer picture of value for mature SaaS businesses with established product/market fits, sales teams, and reputations|
|Provides a broad snapshot of business without getting bogged down by revenue recognition issues||Can offer clues into structural problems, including incorrect pricing models|
|Cons||Doesn’t capture true profitability or cash flow||Doesn’t account for debt|
|Can hide operational issues||Ignores the common early-stage SaaS practice of reinvesting profits for growth|
|Easily manipulated by recognizing revenue differently||Can be interpreted in multiple ways and thus manipulated|
|Best For||SaaS businesses in their first 3-4 years||SaaS businesses with established presences in their market|
|Companies with complex pricing models||Companies who have figured out their pricing model and have high margins|
For small SaaS businesses that don’t subscribe to the hyper-growth model of burning cash to scale ARR, another metric some buyers use for valuation is a multiple on Seller’s Discretionary Earnings (SDE) – essentially, the money that is left over for the owner after all the business’s expenses are handled.
Below is a comparison of ARR Multiples for SaaS industries as of Q2 2023. For the full report, click here.
The average ARR multiple that SaaS businesses receive from acquirers across all ranges is 6.6x.
SaaS ARR Multiples by Industry – 2023
|SaaS Industry||Average ARR Multiple|
Key Metrics & KPIs in SaaS M&A
The next section discusses the most common metrics acquirers look at when valuing a SaaS company. They include:
- Lifetime Value of a Customer (LTV)
- Customer Acquisition Cost (CAC)
- Churn Rate
- Debt-to-Equity Ratio
- Burn Multiple
- Hype Factor
- Future Proof Index (FPI)
While the first four metrics are standard items all acquirers will review, the last three are advanced metrics that only more sophisticated PE and venture firms will use.
|Note: While the valuation multiples listed above set the baseline price for a SaaS company, the factors below can adjust the price up or down up to ~20%.|
Lifetime Value of a Customer (LTV)
LTV is the amount of revenue a customer provides the business over its lifetime. It is calculated by multiplying the revenue a customer generates over a given time period (e.g., month or year) by a customer’s average lifespan. Typically, you will also want to subtract the Cost of Goods Sold, which can be accomplished by multiplying the LTV by your Gross Profit Margin.
SaaS companies with high LTVs will be looked at favorably by acquirers because there is less reliance on constantly acquiring new customers in order to generate revenue, as well as a higher likelihood of customer satisfaction and referrals. Many acquirers will also look at the ratio of a company’s LTV to its CAC (see below).
Customer Acquisition Cost (CAC)
Customer acquisition cost measures what it costs to gain a new customer in a repeatable way over a period of time (usually one year but sometimes broken down over a campaign period). It’s calculated by dividing the total dollars spent acquiring the customer in marketing and sales by the total number of new customers acquired.
CAC is a particularly important metric for acquirers of earlier-stage SaaS businesses since it predicts the ease or difficulty of growing the business. You can see the average CAC for various SaaS niches here.
Churn measures how successfully a company retains users/subscribers over a given period of time (annually or quarterly). It is calculated by dividing the “churned” (i.e., “lost”) annual recurring revenue during the time period by the ARR at the start of the same time period, as depicted below:
For a simple example, a company that started 2022 with $100 but saw $25 of that lost over the course of the year would have a churn rate of 25%, since it lost a quarter of its revenue. Conversely, the same $100 company having only lost $4 of revenue would have an outstanding churn rate of just 4%.
As a general rule, SaaS companies should seek an average churn rate under the industry average of 10%. At this point, buyers are more likely to see that company as having a quality service and a reliable source of revenue.
Debt-to-Equity Ratio and Debt-to-Revenue Ratio
Debt-to-equity ratio measures the company’s financial leverage by comparing the amount of a company’s debts to the amount of its assets. It helps potential buyers understand how much risk they’d be taking on from a debt perspective by acquiring the company. A similar metric, debt-to-revenue ratio, compares the amount your business owes to the amount it earns in a given time period. The equations for both are below:
For a SaaS company to be attractive to acquirers, it should have significantly more in assets than debt. For example, a company with $5M in outstanding debt but with a total shareholder equity of $10M would have a debt-to-equity ratio of .5.
Debt-to-Equity Ratio Benchmarks
Debt-to-income ratio reflects similarly on a business’ reliance on debt, but uses income rather than total equity to measure its health.
Burn multiple refers to the expertise with which a startup generates growth using their available capital. The metric is calculated by dividing the company’s “net burn,” which refers to how much money they spend – by their net new ARR.
If the net burn is higher than the new ARR (e.g., a company burns $2 to make $1) their burn multiple is 2, meaning they are losing twice as much as they gain. If the net burn is lower (e.g. the same company burning $.50 to make $1) their burn rate is .5, since they lose half as much as they gain.
Burn multiple is an essential metric in SaaS due to the sector’s high level of sunken investments and delayed timeline to profitability. With the exceptionally higher business lending rates of 2023 (~10% as of Q2) cash is more difficult to come by, so burn multiple is particularly scrutinized.
The table below provides general benchmarks for early-stage SaaS company burn multiples.
Burn Multiple Benchmarks for Series A SaaS
|Burn Multiple||Investor Perception|
|0.25 – 0.5||Outstanding|
|0.5 – 1||Good|
|1 – 1.5||Mediocre|
|1.5 – 2||Bad|
Hype factor refers to the difference between outside investments in a company and the company’s actual ability to generate revenue. The hype factor formula is as follows:
Consider a SaaS company working with a VC firm to provide capital. In 2023, the firm invests $100, while the company generates $75. This would lead to a hype factor of 1.3, meaning that the company is close to matching its VC funding, indicating some level of stability for a startup. For reference, that same company generating only $25 would have a hype factor of 4, meaning that the company is not sustainable since it requires 4x as much outside capital as it can generate itself.
Hype factor is an important yet often overlooked metric in SaaS company valuations because so many SaaS businesses rely on outside funding, and in hot investing environments like 2014-2021, can over-rely on capital to the detriment of their core business.
Future-Proof Index (FPI)
Future proofing refers to the steps taken to ensure that a business can continue to grow while adapting to new challenges and opportunities resulting from technological innovation.
Future proofing is often presented as a purely qualitative concept, which makes measurement impossible. Future-Proof Index (FPI) was created to give SaaS owners a frame of reference for how prepared their company is to weather the innovation ahead.
The SaaS Future-Proof Index
|Metric||Scoring Criteria||Score Range|
A highly flexible company has gone through any of the following situations without seeing employee turnover greater than 15%:
|1 – Very Inflexible
2 – Somewhat Inflexible
3 – Average
4 – Somewhat flexible
5 – Very flexible
|Clarity of Purpose||A company with a strong clarity of purpose has had a consistent company mission, vision, and value statement during periods of major economic, cultural, regulatory, or leadership change.||1 – No consistency
2 – Little consistency
3 – Moderate consistency
4 – Strong Consistency
5 – Full Consistency
|Historical Financial Strength||
A SaaS company with a strong financial history has either:
|1 – No HFS
2 – Minimal HFS
3 – Average HFS
4 – Good HFS
5 – Excellent HFS
|Level of Debt||
SaaS companies with lower levels of debt have either:
|1 – Extreme Debt
2 – Heavy Debt
3 – Moderate Debt
4 – Light Debt
5 – No Debt
A high degree of customer loyalty is indicated by an
|1 – No Customer Loyalty
2 – Minimal Customer Loyalty
3 – Average Customer Loyalty
4 – Significant Customer Loyalty
5 – High Customer Loyalty
|Total||The addition of all scores in the above rows.||# / 25|
Once your total has been calculated, compare it against the spectrum presented below. Most SaaS companies typically score somewhere between 11-15:
For reference, the following table demonstrates how 3 well-known companies score on the FPI.
Future Proof Index Examples
|The Walt Disney Company||22||Disney’s mission since its founding in 1923 has been to “entertain, inform, and inspire people around the globe through the power of unparalleled storytelling.” Despite its present size and scope, many forget that Disney was nearly bankrupt before its renaissance in the 1990s.
Since that time, Disney has adapted its business model, acquiring other family-friendly media companies such as 20th Century Fox, ESPN, and Marvel; however, they have also done a great deal of work reimagining their existing IPs through live action remakes, regular development of theme parks, and expansion into Broadway shows.
|18||Google set out in 1998 to “organize the world’s information” and has stayed true to that mission for 25 years, advancing seamlessly from search to maps to mobile operating systems to cloud services. Further, it has stymied competition by investing in expensive data centers that give its products an enormous advantage in processing speed.
Where it has fallen short, however, is in preparing for the information discovery sea change that is Large Language Models (LLMs). It will suffer billions of dollars in lost market share at the hands of Microsoft’s ChatGPT over the next several years. Google had access to its own LLM but kept it under wraps too long, allowing its competitor to get a first mover advantage and its strength as market leader to waver.
|Netflix||9||Netflix was the first major streaming service, debuting its streaming product in 2007. The company was paradigm-changing, leading to an incredible run until early 2022, when their competition caught up to them. Since then, Netflix has seen constant decline in market share. Currently, they hold ~20% of the streaming market, down from a peak of 71%, while their competitors, e.g. Prime Video, Disney+, HBO Max, have all steadily increased. Surveys show that content is the problem: While Netflix focuses on original shows, other services have focused on building extensive libraries of existing, popular IP.
Moreover, analysts have decried that Netflix’s core values appear to change approximately every two years, showing a lack of brand consistency that future-proof companies require. Their financial management has also been questionable – with a debt to equity ratio of .69 on a debt of 14.8B as of 2023, they suffer from a bloated budget and high levels of debt.
Getting a Professional Valuation
There are a number of companies that offer valuation services. They range from general business brokers to the big sell side investment banks (Goldman, Morgan Stanley, Houlihan Lokey) to smaller business valuation specialists.
If your SaaS business has an EBITDA north of $30M, you should get these services directly from your investment bank. Companies whose EBITDA is below that number are best off with a boutique valuation company that understands SaaS really well.
How to Sell a SaaS Company
After getting a valuation for your SaaS company, the process of selling the business consists of the following steps:
- Set expectations around the type of deal you’re seeking
- Engage an M&A advisory firm or investment bank
- Run a formal M&A marketing process
- Negotiate final deal terms
- Execute closing and begin earnout
We’ll now go through each step in the selling process and provide insights on what to expect and watch out for.
|Related: See our 2023 report on the Top Boutique M&A Firms.|
Set Expectations Around Deal Type
There is a big difference between having an intention to sell your business one day – stating it as a goal when you start your business, daydreaming about it as the company grows – and the reality of actually doing it. The truth is, if you’ve established a valuable business and get the right help in finding a buyer that sees that value, you will be significantly changing your life. Not only will you gain wealth, but a kind of responsibility you may not have had before wherein a serious, deep-pocketed investor will have expectations over how you spend your time, and will control a portion of the money you expect to receive for your business.
In addition to the loss of control sellers experience during an M&A process, they also have to engage in a kind of future planning they may not have experienced before. Do you want to just cash out and go fishing? Or do you want to partner with a group of financially and operationally sophisticated businesspeople who can make “the second bite of the apple” (i.e. your equity participation in the acquiring company) even bigger than the first. Perhaps through this process, you yourself become an acquirer down the road.
These are the types of questions SaaS owners must explore, both logically and emotionally, as they prepare to sell their company. There are acquirers that are solo entrepreneurs looking to take 100% of your company and operate it themselves, and others that want just 51% with heavy participation from their former owners, who they believe are crucial participants in their company’s next stage of growth. You stand to make more money with the latter type of buyer, but also take on more risk and spend more time and energy. It is helpful to have a sense of the type of deal you’re looking for because initiating the M&A process, and that begins with understanding the types of buyers out there.
M&A typically features two major categories of buyers: strategic buyers (“strategics”) and private equity firms (“PE”). Those unfamiliar with either term may benefit from our article on the topic, but here are the main differences:
Strategic vs Private Equity SaaS Buyers
|Strategic Buyers||PE Firms|
|Description||A company in your industry or a related industry wishing to absorb your company for strategic (rather than immediately financial) reasons||A financial entity that acquires all or some of a company with the intent of reselling it at a profit further down the line|
|Buyer Goal||Increasing their market share, achieving economies of scale, beating out key competition, expanding into new markets, gaining access to a new feature or technology||Enriching their investors by selling the acquired company for many times more than they bought it for|
|Pros||Pays higher cash amounts than PE firms||Much faster deal process|
|Often more financially stable / less dependant on debt||More flexibility in market downturns|
|Cons||Typically purchases outright, eliminating the possibility of equity||Retained equity may be worthless in the event of an unsuccessful deal|
|Sometimes lead to staff cuts due to staffing redundancies||Greater potential for conflict as the PE firm may not care about your vision for the company|
|Best For||Legacy-minded seller||Owner seeking the best possible return, regardless of cost|
Although both acquirers are primarily concerned with the profitability of your company, PE firms are far more numbers-oriented than strategics. These buyers will likely gut your company to remove any inefficiencies before reselling, which can often be difficult for sentimental owners. The process of selling through a PE firm is also longer for the seller because the seller retains equity in the company until the PE firm resells it. Prospective sellers considering a PE firm should be prepared to trade a long deal process in exchange for a larger payout.
Strategics are, by comparison, more understanding than PE firms when it comes to preserving any vestige of your vision for your company. That being said, strategics are often purchasing all or most of your company, which leaves sellers little room to make objections or offer alternatives to their plan for your company.
Finally, many SaaS companies burn a lot of cash in their early stages of growth which can significantly lower valuation. For them, strategics may be a better choice, as they’re more likely to either see the vision of the SaaS product or have an immediate use for it within their business, making unprofitability less of a factor.
Engage an M&A Advisor or Investment Bank
Many business owners are tempted to sell their company themselves after receiving pitch emails from PE firms and buy-side advisors, however doing so is never advisable. Much in the same way that you wouldn’t sell your house without an agent that understands the local market and has connections to interested buyers, selling one’s own company often results in missed opportunities that cost the seller millions of dollars.
The most important choice sellers face at this step in the process is choosing whether to work with an M&A advisor or an investment bank. This decision is particularly important for SaaS owners due to the high growth potential of software businesses compared to other businesses. See the diagram below for more on the differences between these entities.
Because it’s fairly common to find fairweather examples of both types of M&A firms, including those that stay in business for a few years collecting large retainers before closing their doors, business owners should be diligent when interviewing firms. Here are the criteria the SaaS entrepreneurs we interviewed valued most when considering an M&A advisory firm or investment bank:
- Average Client Revenue Range: A good M&A firm will have closed deals with other companies of similar size to yours in the past
- Total Annual Deals: The firm should have a transparent deal history, with multiple deals closed for every calendar year they’ve been in business
- Notable Awards & Rankings: The firm should have a record of excellence as noted by third-party M&A organizations that track the industry
- Specialty & Niche: The firm ideally will have experience in your sector or vertical
When considering who to work with, it’s also worth revisiting your goals for the deal. For example, if the goal is to maximize value in a multi-year process by raising capital, growing the business, then selling to a strategic buyer, then an investment bank will offer the range of services you need. On the other hand, a business owner looking to sell in the near future who values personalized attention throughout the deal process will prefer an M&A advisor.
|Related: See our 2023 report on the Top M&A Advisory Firms in the US.|
Run a Formal M&A Process
Once the company owner is ready to sell, their M&A firm prepares to go out to the market in search of the right acquirer. Before doing so, they create a marketing deck with key financial metrics, competitive differentiators, a demo video, and projections – but most importantly, a story about what makes the company unique and valuable. This document is then circulated to a group of potential buyers.
During the process, the seller should be prepared to share additional documents (after signing an NDA) detailing the state of the company as they attract prospective buyers. As more buyers begin expressing interest, the seller works with their M&A advisor to track and evaluate existing offers until they are prepared to move forward with negotiations.
Negotiate Final Deal Terms
Negotiation begins once valuation and due diligence conclude, consisting of buyer and seller brokering the terms of the company sale through the use of their legal and advisory teams. It begins with the buyer issuing a “letter of intent” (LOI) establishing initial terms and tone under which they plan to purchase the company. The LOI forms the basis of negotiations moving forward, including terms such as:
- Initial Purchase Price: Formerly known as the “down payment,” the initial purchase price actually refers to the total equity value, which is paid at the time of closing
- Intent of Purchase: A description of the buyer’s plans for the purchase (e.g. absorbing it into their own operations, franchising it as a subsidiary of the parent company)
- Consideration Structure: A determination of how the initial purchase price is broken down between cash, equity, and/or stock
- Financing Options: In some situations, payments are made in installments. This is more rare than not but occurs when buyers are making leveraged purchases and do not have the full payout amount available at the time of closing
Once both parties have come to an accord on these terms and due diligence is conducted, both sign the purchase agreement and other relevant legal documentation. At this point, the deal process moves into the “post-closing stage.”
Execute Closing & Begin Earnout
After closing, the buyer and target company work together to integrate resources, systems, and teams. Successful integration can enhance the value of the transaction for both parties. The process typically involves:
- Managing several integrations (teams, communication, systems, culture) between the acquirer and seller companies, often including the elimination of redundancies between them
- Following up with both parties to ensure payouts are being delivered on time and in the agreed upon form
Unlike with the rest of the M&A deal process, M&A advisory firms do not always offer post-closing services. Instead, these would be handled by agreed-upon parties from each company.
Common Pitfalls in Selling a SaaS Business
Building a successful SaaS business takes a lot of effort, time, and investment. However, the high stakes of the M&A deal process make it easy for business owners to make costly mistakes that could easily be avoided. The most common of these mistakes include:
- Trying to sell too soon: According to the M&A professionals we interviewed, approximately 50% of businesses are not sellable. SaaS company owners should be cautious before entering into a deal process before they have had a professional valuation done on their company to ensure they are likely to get the deal they’re seeking.
- Using the wrong valuation model: As described in the above section, SaaS companies typically use a multiple of ARR for valuations due to their high cash-burn model. However, more established SaaS businesses do sometimes use a multiple of EBITDA.
- Focusing on the Multiple: Many owners focus intently on getting the highest multiple, but the definition of the metric being multiplied is just as important. Even simple-sounding words like “Revenue” “Expenses” “COGS” and “Profit” can be defined in totally different ways.
- Trying to sell by yourself: Even in cases where a business owner has sold a company before, it’s always a good idea to work with an experienced M&A advisory firm to get the best possible outcome from a rapidly-changing market. Your advisor should understand how to appeal to specific buyers and optimally, how to produce a bidding war.
Post-Valuation: Taking The Next Step
When we asked entrepreneurs who exited their SaaS businesses what they wish they knew before they started the M&A process, many said they wish they understood how slippery the deal process can be, and how that naivete can lead to real-world problems in their earnout period. Promises made by the PE firm or strategic buyer ended up being broken, not usually formally but technically, due to something as bizarre as a definitional shift in the word EBITDA or an oversight in the fine print around payment terms. This is, once again, why it’s essential to work with an M&A advisory firm.
We also encourage you to speak to other SaaS owners who have exited and ask them candidly about their experience. Selling a business is life changing, and ideally that change is a positive one. The post-deal period can be several years of prime life, and you want to go into it with a clear understanding of what’s to come.
If you have any questions about selling a SaaS business, we are always happy to talk to fellow owners and share our experiences. You can reach our CEO Evan through the author box below or the contact page of this site.
- SaaS Valuations: How to Value a SaaS Business in 2023 (FE International)
- 4 Key Metrics to Calculate a Private SaaS Valuation (Flow Capital)
- How to sell SaaS: a model for main factors of marketing and selling software-as-a-service (Lecture Notes in Business Information Processing)
- How Do Corporate Valuation Methods Reflect the Stock Price Value of SaaS Software Firms? (ISM Journal of International Business)
- Do We Know How to Price SaaS: A Multi-Vocal Literature Review (ACM Digital Library)
- From Impossible to Inevitable: How SaaS and Other Hyper-growth Companies Create Predictable Revenue (Aaron Ross & Jason Lemkin)
- How to Value a SaaS Business (The Bloom Group)
- The Top Five Metrics Driving SaaS Company Valuations (Forbes)
- SaaS and the Rule of 40: Keys to the critical value creation metric (McKinsey)
- How to Value a SaaS Business (Moore & Stanley)
- How to sell SaaS: a model for main factors of marketing and selling software-as-a-service (Lecture Notes in Business Information Processing)
- From Impossible to Inevitable: How SaaS and Other Hyper-growth Companies Create Predictable Revenue (Aaron Ross & Jason Lemkin)
- An Empirical Study of Software Companies’ Merger and Acquisitions in the Software-as-a-Service Market (International Journal of Business & Management Studies)
- Sell a SaaS Business (FE International)
- How to Sell Your SaaS Business: The Ultimate Guide (Scaleview Partners)
- SaaS M&A Snapshot: Target Market & Buyers (Software Equity Group)
- M&A Integration Strategy: SaaS Executives Share Five Lessons for Acquiring “New and Different” (M&A Leadership Council)
- SaaS Technology Preparedness for Acquisition Due Diligence (KMS Technology)
- Common Post-Closing Disputes in Private M&A Deals – How to Avoid the Pitfalls (Martin LLP)