SAAS Business Valuation

Revenue Multiple Method

This method involves using a general industry multiple to value the business, such as 4-6 times the business's annual revenue. For SAAS business this is usually the preferred method, since initially most SAAS businesses won’t make a profit as any revenue is put back into growing the business.

According to a report published by acquire.com, a marketplace to buy and sell businesses, these are the average multiples they calculated on self reported data from transactions that closed.

Average transactions as a multiple of Revenue

Average transactions as a multiple of Profit

Why this doesn’t work for pre-revenue companies

While most of the time valuing a SAAS company as a multiple of revenue works, for very early stage companies this can be a problem. The problem is this method does not take into account the value of any Intellectual Property (IP) and software that was developed.

Let’s say you have a pre-revenue or low revenue SAAS, that has developed an innovative screen capture tool. This tool allows influencers or teachers to easily demonstrate applications on their computer and publish the videos quickly. This tool took time and knowledge to build, but if no copies or licenses have been sold, then there is no multiple of annual revenue to value the business on. In this case the more important metric is to value the business based on the software value.

Cost-to-Duplicate Valuation Method

Valuing the software can be done a couple of ways, one is the cost to develop this software from scratch. If it would take two engineers six months of work, plus a UX design person for three months, you would calculate out the cost (2 people x 6 months x 20 business days per month x hourly rate for engineer) + (1 person x 6 months x 20 business days per month x hourly rate for UX design). This would give you a rough estimate, but there is no guarantee that you would have a complete product at that point.

It’s like building a house vs buying a house, the house that is already built has been de-risked because all of the permitting, contractor issues, supply issues have been resolved to the point where the house is complete. When building a house all of those issues lay ahead, so there is more risk. The upside to building a house is you can design every aspect of the building and make sure it meets those specifications along the way. This is also the same in software, the product that is already built may not meet the quality standards you have, but has been significantly been de-risked by having a working product.

Once you have an estimated development cost, then you should add in value for being able to go to market right away. In our example it would take six months to replicate the product in the best case. How much business have you lost over those six months? If you are good at marketing then having a ready made product you can put your marketing behind, can vastly accelerate your ROI.

Based on the product, the value of the software can be anywhere from tens of thousands to millions of dollars. Assuming this is a small pre-revenue SAAS business then it’s more likely to be in the tens of thousands. If there is any revenue being generated, you would add the software value to the revenue multiple to come up with a final value.

Get revenue first

The value of the SAAS goes up quickly with annual revenue, so if you are building a SAAS business it is worth your time to generate revenue before trying to sell your business. In a report from acquire.com, pre-revenue startups get acquired for $12,695 on average. This site does not list many pre-revenue SAAS businesses, so this is most likely on the higher end of what you can expect. If you have a small amount of revenue, less than $100k per year the multiples go up quickly, the same report showed a range of 10x to 300x revenue for a multiple. $50,000 dollars in revenue times a 20x multiple is 1 million dollars, not to say this is typical but is on the spectrum of what is possible. Even if we take the average from the report of 7x, the $50k revenue producing SAAS would go for $350k. All of this to say is don’t stop after developing your SAAS, get customers and revenue before trying to sell for the best return.

The flip side is that, if you are a savvy buyer of a SAAS business then buying a pre-revenue ready to go SAAS product can make a lot of sense. This is especially if you are accomplished at marketing products. The risk is the product is unproven and the technology may be subpar unless you do a full evaluation before the purchase.