There are so many aspects that you need to consider to evaluate a SaaS product rather than just the revenue growth. Undoubtedly, valuing a business tends to be an emotional thing, and it is one of the reasons why it is wise to use M&A bankers. They provide fair, unbiased and reasonable valuations for a business. If you look from the buyer’s end, you will note that they want to do well and work on a price that will favorably close the acquisition as quickly as possible.
Here are some considerations that you may need to check if you are planning to buy or sell a SaaS business.
Firstly, it is necessary for you to consider the top line of the revenue that the company is generating. If it is below $2m annually, you will not have sufficient cash flow to hire additional staff or work on growing the business. With small margins, it becomes more trouble than it’s worth to purchase small entities. Any SaaS companies that fall under 10m is a nonstarter for many investors. Almost all buyers are interested in companies that can generate tens of millions in revenue.
One thing that the buyer looks for when he is planning to acquire a company is to see if the revenue and team are large enough. Of course, the business also needs to be one that is self-managing. There is no doubt smaller companies bring in more significant risks.
Quality of the Revenue
It is necessary for you to segment the customer base. If you see that it is mostly in one small market or if the focus of the product is on a few large companies, there is a high-risk of substitution or shrinkage especially when there are some fundamental changes in the industry. It is wise to have a good spread of customers across various sectors, locations, industry types, company size, and the contract size. Now, this is the gold standard that you need to follow:
Installed Base Health
One of the critical valuation metrics is the company’s established customer business. Without a doubt, if the customers are quite happy with the product, you will observe less churn. This will contribute to a stable customer base and revenue. But if the installed base is going to shrink, you need new customers to maintain current growth. Clearly, if your installed base is facing disruption, you’ll need to find a whole lot of new customers just to stay at your baseline. For a newly acquired business, this can be a huge setback.
It is necessary for you to know if the pipeline is growing. There should be conversion rates that are healthy from visitor to MQL, to SQL, to Quote to close. It is essential for you to know if the customer acquisition costs are well managed and are under control. Is the company following a provable or scalable funnel or set of levers to increase the lead flow? The acquirer needs to have confidence that this business can grow. If you are a seller, this information will help you in getting a better deal.
Team and Culture
It is necessary for you always to put yourself in the shoes of a buyer. It is essential for you to know if the buyer is going to be happy working with your team. Also at the same time, you also need to know if the team is willing to work with you through the transition and future opportunities.
Is your team strong enough to sustain some of the natural bumps that occur because of any significant change? Will the acquirer and the team feel happy about the changes that are going to take place. There is a higher risk when the company is small, and you might not find a buyer that easily. Even larger teams face similar challenges, so it is something to be aware of at all levels.
The Market Position
Is there a super dominant player in the market that belongs to the same category as yours? Is your business mainly dependent on a different platform? It is vital for you to have a fair idea of how the future is going to be for this particular sector. Know how many competitors are there in this sector.
Take time to understand if your business is stacking up well in the competitive landscape. It is essential for you to check if the market share is validating the information. If there are more than ten competitors that provide similar kinds of services, it is hard to get the attention of your buyer easily.
You need to use these and other metrics to come up with a weighted model that provides you with the ballpark valuation for your company. These are the same principles you have to follow if you want to acquire a company. This model cannot be used to evaluate every company that you find in the market. Use your wise judgment when you want to assess the company’s value.