Software as a Service (SaaS) business is a growing market; one that is unique with special requirements to consider for Mergers & Acquisitions (M&A).
What are some of the best practices and important considerations of anSaas business valuation and its selling quality? We will discuss them in this article.
The Following Discusses The Method Of Valuing An SaaS Business For Business Valuation:
At present, the method of SaaS Valuation is a popular debate topic amongst investors, small business entrepreneurs and advisors in Singapore because an SaaS business is essentially a technology business. Hence the primary question is: which is the first multiple to look at – the EBITDA, the SDE or the Revenue?
Then to make the marketplace more confused, the revenue multiples of unicorn SaaS businesses are crazy high as compared to that of the smaller ones; and so the next question becomes: which value is the right one to use?
Actually the values from both circumstances are right – they are just involved in two completely different investment and business proposals.
Hence the business valuation of SaaS boils down to the core difference between the unicorns and the smaller SaaS businesses – the size and growth (or growing potential); and this will be discussed in greater detail.
Business Valuation: Considering The Size Of An SaaS Business
As most SaaS businesses start small, let’s begin the discussion with a small SaaS business:
The business valuation of a small SaaS business that has a maximum value of $5,000,000 or less, uses the Seller Discretionary Earnings (SDE) especially when it has a relatively slow growth rate, and it is operating in the absence of a management team.
SDE refers to the remaining profit after deducting all the necessary costs involved in the sales of goods and important (i.e. non-discretionary) operating expenses. This profit will be given to the business owner; and here, the businessman’s earnings or dividends can also be returned to the profit number.
SDE = Revenue – cost of goods sold – operating expenses
+ owner compensation
As small businesses are usually operated by owners, they are owner-dependent. These owners tend to take salary for their work, which may not tally with the market rate, and/or use the business revenue to buy some personal items.
To capture the SaaS business’s true earning power, such owner related expenses and salary become the acceptable add backs for the final business valuation – and the SDE helps with this.
As the SaaS business grows, the situation becomes different. Now, we look at the unicorns of the SaaS industry:
In a unicorn SaaS business, there is a larger staff strength; a management team; a board of shareholders; and a CEO or a general manager. The CEO runs almost everything related to the business operations while the shareholders are usually less active in it. Hence the owner compensation should then be included in the business valuation to show the business’s true earning power.
The latest comparable Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) multiple is then used here, which is almost exclusively used across companies of value over $5,000,000 during M&A.
Generally, the debate of which comparable multiple to use for the valuation of SaaS business ends with either using the EBITDA or the SDE – both can best estimate the future cash flow of the business and hence a substantial basis for the business valuation.
However, at present, the EBITDA generated for SaaS business in Singapore can be zero: as expanding an SaaS business is an investment involving significant sunk and upfront costs, these impending amounts are naturally expensed in the EBITDA, which then becomes a poor proxy for the business’s future cash flow.
Such situations can be avoided with mature businesses that have a recurring revenue model and a strong number of loyal customers – with relatively less expenses, the future profits will increase significantly.
Business Valuation: Considering The Growth Of An SaaS Business
The business valuation of a growing SaaS company is based on its measuring revenue; and this philosophy in valuation cannot be applied to a static SaaS business where its revenue becomes redundant to the forecast of its future profits. This will make the business valuation not useful.
With all the above in mind, the following test can be done to ultimately decide on the appropriate multiple to use for the business valuation of an SaaS company. Click here to learn more about valuation methodologies of a SaaS company.
Contact us for an in-depth review of your Saas business valuation.