This article is part of our Valuation by Business Model series, in which we provide you with information on what makes your particular business model unique when it comes to valuation. For more in-depth reading on valuation, see our post How to Value a Website or Internet Business.
Software as a Service (SaaS) is a unique and growing industry, and one that requires special considerations when it comes time to selling. As the market-leading advisor for SaaS business sales, the team at FE International answers questions every day about the best practices of selling a SaaS business and which SaaS metrics should be measured.
In this post, we leverage our experience and insights from more than 50 of our SaaS sales to take a deep dive into SaaS valuation and salability, providing the definitive resource on selling a SaaS business.
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How to Value a SaaS Business
How to value a SaaS business is perhaps one of the hottest and most ambiguous debates among small business entrepreneurs, investors and advisors at the moment. The debate ultimately distils down to whether a multiple of revenue or earnings should be applied to the business and, correspondingly, what that multiple should actually be.
Stories of wildly high revenue multiples for unicorn SaaS businesses can seem at odds with the modest earnings multiples for smaller SaaS businesses, which serves to confuse the information in the marketplace. So which one is right? The answer is both, but they are entirely different investment propositions.
The difference between the two situations comes down to the size and growth of the businesses in question, as we explore in depth below.
SDE vs. EBITDA vs. Revenue
Most small businesses valued at under $5M are valued using a multiple of seller discretionary earnings (SDE or sometimes also called seller discretionary cash flow).
SDE is the profit left to the business owner once all costs of goods sold and critical (i.e. non-discretionary) operating expenses have been deducted from gross income. Crucially, any owner salary can be added back to the profit number too.
More easily it is described as:
SDE is used for small business valuation to demonstrate the true underlying earnings power of the business. Most small businesses are owner-operated and somewhat owner-reliant and therefore have an associated owner salary and expenses. The owner is likely to pay themselves a salary for the work and pay a number of personal items through the business for tax efficiency. These are acceptable addbacks to reflect the true earnings power of the business.
The situation changes though as businesses grow larger. In bigger companies, there are more employees and more management personnel. Similarly, the ownership structure tends to fragment with several shareholders who typically play a less active role in the business, often hiring a general manager to oversee operations. In this situation, any owner compensation or discretionary expenses should be reflected back into the business to show its true earnings power. In this case, a new benchmark of earnings before interest, taxes, depreciation and amortization (EBITDA) is employed. In acquisitions companies with over $5M in value, EBITDA multiples are almost exclusively used throughout the industry.
For most businesses, the valuation benchmark debate stops there. Either SDE or EBITDA is considered the best proxy for the business’ future cash flow, and is therefore the basis of its valuation. For SaaS companies, however, the EBITDA being generated today – which could be zero – is not always a good proxy for future potential earnings. This is because growing SaaS businesses make significant up-front and sunk investments in growth, which are all expensed in current EBITDA. Owing to their recurring revenue model, assuming customers stay with the business, the profit in the future will expand significantly as the business matures and spends less on these items.
Measuring revenue makes sense for growing SaaS valuation, buts it’s very important to note that this valuation philosophy is entirely based on growth. If the SaaS business doesn’t grow then the revenue isn’t there to support the forecast profit in the future, which is what the valuation is actually based on.
So what does this all mean for your SaaS business? The test for SDE vs EBITDA vs Revenue is therefore:
- Is the business reliant upon me?
- Are revenues growing less than 50%+ YoY?
- Does the business generate <$2M revenue per year?
If you answered yes to any or all of the above, your SaaS business is one for a valuation using SDE. Investors will appraise your business based on this benchmark alone and apply a multiple to arrive at the final business valuation. If you answer no, EBITDA or revenue might be more appropriate.
This leads to the next question, how to decide the multiple?
Finding the Multiple
The multiple is one of the most important pieces of the equation and is affected by dozens of factors related to the business. Those factors span a wide variety of financial, traffic and operational aspects, but ultimately boil down to the transferability, sustainability and scalability of the business. Any operational or market factor that directly or indirectly impacts these core drivers will influence the multiple.
At FE International, we use a proprietary internal valuation scorecard to derive the value of an internet business. We’ve discussed this in depth in our post on how to value an online business. Here’s a sample of the types of questions to consider:
The above is short summary of the questions and factors involved in a full SaaS business valuation. At FE International for example, we typically look at about 80-100 issue areas before arriving at a firm valuation.
Ok… But How Much Is My SaaS Business Worth?
SaaS businesses typically fall within the 2.5x – 4.0x annual profit (SDE) range.
This is quite a large range. If your business is making $100K in profit per year, that’s a valuation difference of $250K vs. $400K, which is no small sum of money. How do you know where your business is in that range?
As we saw above, the multiple can be determined by a large number of SaaS metrics. In the initial assessment it is useful to filter these variables into a few that have the most influence:
- Age of the business: A SaaS business with a longer track record demonstrates to a buyer that it has proven sustainability and is also easier to predict in terms of future profit. Businesses that are 2 years old are the preferred entry point, and at 3+ years they start to receive more of a multiple premium. Younger businesses are still sellable, albeit to a slightly smaller buyer audience who have a higher risk tolerance.
- Owner involvement: Part of the appeal of running an internet business is the potentially passive nature of the income it brings. Businesses that require relatively little time (e.g. 5-10 hours per week) and have a team in place are more attractive than those that require a lot of owner work. Outsourcing can help here (see more on that below). The other dimension to this is the technical involvement of the owner. If the buyer must replace an owner that is performing a highly skilled role, this will either increase the replacement cost or put off non-technical buyers, which reduces overall demand for the business.
- Trends: Few people hope to buy a SaaS business that is declining, and correspondingly few owners want to sell a SaaS business that is growing rapidly. The key is to sell a business that is trending consistently and, ideally, modestly upward. Naturally, the faster the business is growing, the more the multiple will stretch toward the premium end.
- Churn: It’s well documented that customer metrics are of vital importance for SaaS business owners and consequently they are of great interest to business buyers. Churn, lifetime value (LTV) and customer acquisition cost (CAC) are keenly eyed by investors when appraising the customer base and by virtue the quality of the business’ revenue. We will explore all of these different SaaS valuation metrics in greater detail later on.
The diagram below should give you a good feel of where your business could be:
While the general valuation drivers above are a key consideration, it’s important to note that every business is unique and each SaaS business has its own merits and draw backs.
As the valuation process goes deeper, more business model-specific factors come into play when determining the final multiple.
Which SaaS Metrics Matter Most?
Investors looking to buy a SaaS business are looking for points of strength and differentiation. To determine the points of strength and differentiation investors will often look at a few key metrics. Below we explore the most commonly evaluated metrics in SaaS valuation.
Churn is a significant driver of valuation because it touches upon all the key factors that impact the perceived future cash flows of a SaaS business. Its importance of this SaaS metric should not be underestimated when you consider the long-term impact on the business. Taking the below example of two companies with 5% and 20% annual churn, the corresponding revenue after 10 years is markedly different.
Provided there is a consistent flow of new customers at an acceptable cost of acquisition rate, low churn will allow recurring revenues to grow, improving the growth rate and reducing the risk of value loss over the long term. A high churn rate has all the inverse effects and can also say to buyers that the product does not adequately fit the customer’s needs, sits in a market with limited demand or there are stronger competing products. This would imply that the product requires further development at their expense.
How Much Churn?
The importance of churn is widely accepted. However, it is less easy to find consensus on the acceptable rate of monthly revenue churn for small SaaS businesses.
Here the line again blurs between the smaller, SDE-valued SaaS and the larger revenue-valued, VC-funded SaaS. Bessemer Venture Partners, an investor in VC-funded SaaS businesses, says an acceptable churn rate for these is in the 5 – 7% range annually (0.42 – 0.58% monthly). This is also supported by Pacific Crest’s Private SaaS Company Survey that shows roughly 70% of surveyed large SaaS companies had annual churn in the <10% range, with 75% of those at 5% or under.
Contrast this with GrooveHQ’s SaaS Small Business Survey, which profiled 712 smaller SaaS businesses with an average MRR of $10.5K and found the average monthly churn rate was 3.2% (annualized that is a 32.2% churn rate). Similarly, Open Startups sampled 12 companies with an average $18.9K MRR and found a median monthly customer churn rate of 5.4% (46% annually) and monthly revenue churn of 11.2% (75% annually).
So why the substantial difference? It comes down in large part to which customer segment the business is targeting.
To begin with, most SaaS businesses focus on servicing the needs of small to mid-size businesses (SMB). Small businesses have lower demands and less sophisticated needs, so this is an easier point of entry than enterprise-grade software. The challenge though is that smaller customers tend to have higher churn rates. Generally speaking, SMB customers tend to alternate SaaS products more regularly because switching costs are low and are more likely to go out of business.
Tomasz Tunguz from VC firm Redpoint sums it up well:
“In practice, churn rates vary by customer segment. Startups serving SMBs tend to operate with higher monthly churn, somewhere between 2.5% and 5%+, because SMBs go out of business with greater frequency and tend to be acquired and managed through less retentive channels, e.g. self-service. In the mid-market, which I’d define by average customer revenue of between $10k and $250k loosely speaking, the churn rates I’ve seen are between 1% and 2% per month. Enterprise companies, those with customers paying more than $250k per year are typically closer to 1%. As the spend per customer grows, startups can afford to invest significantly more in retaining the customer, hence the improving rates.”
This latter point is also vital to the difference in churn between cash-rich and cash-poor SaaS businesses. The cash on hand that enterprise-level and VC-backed SaaS companies have to spend on sales and client retention personnel versus what is available to smaller, owner-operated SME-facing SaaS businesses is not comparable at all.
So what is an acceptable churn rate for smaller SaaS businesses?
We took data from a sample of the last 25 SaaS sales at FE International ranging from $50,000 to $2,000,000 in sale value across a variety of niches in both B2B and B2C. We found a monthly customer churn range of 1.0% to 11.0%, with an average of 4.7% (annualized 44.1%). Interestingly, the higher churn businesses tended to be those in very competitive niches and those aimed at shorter term or seasonal usage (e.g. recruitment).
Our findings map similarly to Tunguz’s observations of customer churn, which he thinks to be 3-7% for SME-focused SaaS while lower for mid-market and enterprise grade:
So where to end up? Higher churn is almost a fact of life for smaller SaaS businesses. The focus for investors should in part be on improving the churn rate where they can (more on that below) but more fully placed on customer acquisition to replace those lost clients.
2) Customer Aquisition Cost (CAC) and Customer Lifetime Value (CLTV)
The Customer Acquisition Cost (CAC) is the total marketing and sales cost to acquire one additional customer. Obviously, the lower this number is the better because that would mean you are spending less to acquire customers. However, there is no “golden” number when it comes to CAC because each SaaS business is going to be different. To make an apples to apples comparison you will need to incorporate an additional metric – Customer Lifetime Value (CLTV).
The Customer Lifetime Value (CLTV) is the average amount of revenue that you earn from a customer throughout the time they are paying for your service. The higher your CLTV is the more valuable each new customer is to your business. Just like with CAC, there is no standard CLTV number. Once again, the number will vary depending on your business model, market, competition and a multitude of other factors.
The CLTV/CAC Ratio
In order to truly get the most use out of these two metrics you’ll need to compare them to each other. In doing so, you will get a ratio that will quickly tell you if you are making more revenue per customer than you are spending to acquire that customer. This allows you to measure the return on investment of your marketing efforts and determine if your growth strategy is working.
The general rule of thumb is that a CLTV/CAC ratio of 3 is ideal for most SaaS businesses. This will allow for enough cushion to account for a dip in the CLTV or an increase in the CAC and still be able to generate a healthy profit margin.
3) MRR vs ARR
In small, self-funded SaaS businesses, the temptation is to sell reduced annual plans to increase top-line revenue and improve cash flow to reinvest into growth. While in many situations this is necessary, from a valuation perspective it will hold the business back. The same goes for selling lifetime plans – these are a big no-no when it comes to increasing the value of a SaaS business.
SaaS metrics of revenue, in order of value to a buyer:
This is often the opposite of what an owner of a business will look to do, especially when looking for growth capital. Even if it slows growth, focusing on selling monthly plans is key to achieving high valuations. We would usually value MRR around two times higher than equivalent revenue from lifetime plans, so this can often outweigh the benefits of the short-term cash flow boost.
The average SaaS business we sold in 2015 had a 4:1 ratio of MRR to ARR – this is an ideal mix to aim for to maximize valuation. Generally, these products will have annual plans priced 10-20% less than monthly plans and years of ARR churn data. SaaS products with a higher ratio of annual plans would see a lower valuation as the revenues are less predictable.
Other Factors to Consider When Valuing a SaaS Business
Aside from the SaaS metrics that we just touched on, there are various other important factors that need to be considered in the valuation process. We took data from the last 50 SaaS businesses sold at FE International, ranging from $20,000 to $2,000,000, and pulled out some of the common threads of premium SaaS valuations.
1) Customer Acquisition Channels
Acknowledging the higher rate of churn that smaller, SME-facing SaaS businesses experience, customer acquisition is understandably a focal point for evaluating the longevity of these businesses. If the business is losing 30-50% of its customers per year, the only option is to add a significant number of new customers each month to counteract the loss (at least in the short to medium term).
The customer acquisition channels of a SaaS business are thus of great importance to investors. Buyers tend to evaluate these in terms of concentration, competition and conversion.
● Concentration. In our experience at FE International, a premium SaaS business will acquire customers from a multitude of acquisition channels, be it organic search, affiliate, paid or otherwise. Having a diversity of channels not only reduces the dependency on one channel but also proves its monetization in multiple ways. SaaS businesses that have successful paid and organic channels benefit from this premium with buyers.
Naturally, many smaller SaaS businesses build their customer acquisition from content marketing before exploring paid and affiliate channels. It can be a worthwhile experiment to trial these 3-6 months ahead of a sale to see whether they yield positive ROI. Not only will this improve the value of the business’ earnings (and thus the SDE for valuation) but it will demonstrate to buyers that the business can be monetized in multiple channels.
● Competition. The defensiveness of each acquisition channel is of interest to investors when evaluating their strength. If the business has a strong backlink profile and ranks well for a high number of relevant keywords this is considered a strong, defendable platform for organic customer acquisition. Two good examples of this include Sifter and Restaurant Engine, both of which have used content marketing and SEO to build relevant search terms for their products.
On the flip side, if the business is engaged in price-wars in paid search with competitors, this is understandably considered a weaker acquisition channel. Search “project management software,” for example, to see ads for several different well-funded companies competing for the term. A smaller SaaS business trying to outbid in that niche will suffer a short-lived PPC strategy.
● Conversion. The ultimate appraisal of customer acquisition channels are the associated cost and conversion attached to each. Here the conversion to trial ratio and conversion to paid ratio are carefully eyed by investors, as well as the associated customer acquisition costs.
To summarize, a premium SaaS business is one that has multiple customer acquisition channels with high defensiveness and solid conversion metrics for each.
2) Product Lifecycle
Eventually all software needs development to keep up with customer requirements or to grow the business further. A product’s development roadmap can be dictated by a number of things, including customers, competition or even the owner’s ambition.
While every SaaS business is unique in its development requirements, when the business comes to market, it’s generally best practice to have the product in a high point of its development life-cycle, in other words, not requiring a major update any time soon. This gives the new owner some runway ahead of any major development and provides some comfort that the seller hasn’t simply given up on the business and is passing over ownership at a time when the product needs care and attention.
In the diagram above, it’s the equivalent of selling at point A, where the software is maturing, and point B where the software has aged too much and is in need of development to promote further sales. Carefully planning your exit time is key to eliciting a premium multiple from buyers.
3) Technical Knowledge
As mentioned briefly (see: general factors), the amount of owner involvement in the business and particularly the nature of the work can be a sensitive valuation factor for SaaS businesses. At first this might seem counter-intuitive to a SaaS entrepreneur. More technical input from the owner (i.e. development) suggests a sophisticated product, which implies unique IP and a high-quality product.
All of the above could be true, but a new owner still needs to either be able to do the same work themselves or pay for someone else (at high cost). Factoring this into the SDE will ultimately lower the valuation.
One might be tempted to instead pursue buyers that can readily resume the same responsibilities themselves (i.e. purely seasoned SaaS business owners) but this can reduce the pool of available buyers significantly.
To put it into context, of the last 25 SaaS sales at FE International, 65% of them sold to new owners that would describe themselves as non-technical. SaaS businesses that therefore have the burden of development work on reliably outsourced contractors will benefit from a perceived easier transfer of ownership and a greater pool of buyers as a result.
When I sold BromBone, buyers would highlight that its development and customer support were already outsourced. The only role they needed to replace was my marketing outreach, which meant it was an easier business to take on. Eventually we sold to a non-technical buyer for a great valuation. –
Chad DeShon, Founder of BromBone
Competition in the niche is of great interest to buyers when evaluating a SaaS business. Clearly the level of competition is important to understand for any business purchase, whether an AdSense blog, an ecommerce business or lead generation website.
In SaaS though it becomes of acute interest because of the generally higher number of VC-funded players in the industry and the high development costs associated with the business model. A smaller SaaS business in a highly competitive niche will tend to find itself under-funded and unable to compete with the development efforts and features of better-funded, VC-backed SaaS companies. A good example of this is 5pm, a small SaaS operating competing against huge players like Basecamp and Asana.
What Can You Do to Increase the Value of Your SaaS Business Before a Sale?
An exit strategy for any business is crucial before a sale.
You can add hundreds of thousands of dollars of value to a business by taking the right steps before a sale.
Naturally not all the valuation factors are addressable (e.g. competition in the niche) but there are a number of strategic moves you can make to increase the value of your SaaS business before a sale.
Below we discuss six key topics to think about in the run up to the sale.
1) Reduce Churn
With churn such an important aspect of SaaS valuation, it’s a key element to try to reduce ahead of coming to market. There are many ways to reduce churn and a full exploration of these is well beyond the scope of this article, but below we’ve highlighted some of the best writing on the topic:
3 Things We Did to Reduce Churn By 68% by Josh Pigford at Baremetrics
Pigford discusses a suite of tactics that helped reduce churn at Baremetrics, including, controversially, blocking the ability for users to self-cancel. A highly interesting read.
How One SaaS Startup Reduced Churn 71% Using “Red Flag” Metrics by Alex Turnbull of Groove
Turnbull discusses an interesting, analytics-based approach to reducing churn by analytically detecting when a customer is about to cancel their account and pro-actively step in and try to prevent it.
Customer Onboarding: Your Secret Sauce to Reducing SaaS Churn by Shayla Price of KISSMetrics
A number of larger SaaS companies talk about the importance of on-boarding, and Price’s authoritative post discussed in detail the refinements that SaaS owners can make to customer on-boarding, including feature education and upselling.
2) Outsource Development and Support
As touched upon in the valuation drivers above, there is both a ‘passivity premium’ and a non-technical premium that can be attached to SaaS businesses that have effectively and reliably outsourced development and customer support.
Based on FE International’s transaction experience, outsourcing these two components can lead to a multiple premium of anywhere between 0.5x – 0.75x. It can also reduce the buyer’s assumed owner replacement cost which lifts the business’ earnings for multiplication and thus the valuation even higher. This double-win means that effective outsourcing is one of the greatest levers of exit value for SaaS business owners. [Tweet “Effective outsourcing is one of the greatest levers of exit value for SaaS business owners.”]
The focus here should be on effective and proven outsourcing. A haphazard attempt to move customer support to an unproven call center in the Philippines will not be regarded favorably. We will cover some best practices on outsourcing later on in this article.
3) Secure Intellectual Property (IP)
It might seem obvious, but a surprising number of business owners fail to properly secure their intellectual property ahead of a sale, which can have detrimental effects on the transaction later on.
Securing IP is very important for SaaS businesses, particularly for transactions of >$500K where the cash check being written starts to become significant. Ideally this should have been pursued in the early stages of the business’ development but there is no harm in retroactively applying for a trademark ahead of a business sale. You can do this through the United States Patent and Trademark Office. Trademarks tend to be easier, shorter and less expensive to apply for than patents.
Securing IP doesn’t just stop at trademark filing. Any individual that was involved in writing code or developing the product should be asked to sign an IP assignment for their work. This is particularly relevant to contractors hired from freelancer marketplaces as well as any other third-party company used. This is a standard due diligence request for larger ($500K+) larger SaaS sales but is worth securing right from the outset on any sized business.
4) Document the Source Code
A well-documented, annotated and tested source code is a distinguishing factor of premium-valued SaaS businesses. Particularly on the upper end ($500K+), well-documented code is almost a must-have for investors that are looking to scale the business into 7-figures and beyond. It can be a deal-killing issue and is one that is readily avoidable through adequate preparation ahead of coming to market.
5) Position the Product
As we looked at above in the product lifecycle analysis, where the product is at in its development cycle when it comes to market is important to investors and influential on the exit multiple. Business owners plotting a sale should think about planning their next major upgrade 3-6 months ahead of going to market.
This has a number of short and medium-term benefits. First, it brings some immediate additional earnings to the current owner, assuming a positive uptake and increase in trials for new customers. Second, it lifts the earnings figure (the SDE) which forms the basis of the sale valuation. Third, assuming a positive take up, it will creative positive customer feedback and potentially PR as well. Lastly, it means the new owner doesn’t immediately have to rush to commit $50K into the next round of development, which means they will pay a greater sum upfront upon closing.
6) Avoid Discounting
Tempting as it can be for some business owners, launching an unprecedented sale of annual plans to book a large amount of revenue ahead of a sale is not a wise strategy. Sellers have been known to do this to inflate the valuation ahead of a sale and to generate additional cash. Unfortunately, all buyers see through this strategy and either discount the relevant months or steer clear of the sale entirely. Unserved portions of packages sold on annual plans are often rebated to a new owner, so this is a pointless exercise.
The key to a successful exit is to continue to run the business in a similar fashion in the months before and during the sale. If a sale is seasonal (e.g. Black Friday), that is an acceptable event to run a discount. If it’s outside of normal proceedings, its best to avoid discounting altogether.
Salability: How Attractive is Your SaaS Business?
Ahead of going to market, you’ll need to look at the salability of your SaaS business, or rather, how attractive it looks to buyers AND how attractive it is to own. This is broader than just the fundamentals discussed thus far, it comes down in large part to the operational setup.
Here are some tips to help you improve operations efficiently and effectively:
You’ll need to have detailed financials for your business in order to prepare for a sale. Accounting applications, such as QuickBooks, can be a big help, but make sure your accounting is up to date – and keep it that way as you enter the sale process.
Details are key, and so is organization. Serious buyers are unlikely to sift through months of financial records and tax returns to determine whether the investment is worth it. Luckily, a good broker can assist you in this process.
You should also be prepared to give prospective buyers any analytics you have for past and current ad campaigns, email data and website traffic.
2. Operating Procedures
Your business doesn’t operate itself, even if you have a relatively passive business model. Prospective buyers will need to know the responsibilities involved in your operation, so document all of your daily, weekly and monthly processes and procedures. This will make the transition faster and easier for both of you.
Moreover, buyers may be more inclined to pay a premium for businesses with well-documented operations, so this step could easily translate to a higher profit for you. There are some useful software applications for writing standard operating procedures (SOPs) quickly like SweetProcess and some useful guidance online about writing best in class documentation.
Removing myself from the business and getting it to a point where it could run on “autopilot” was a goal from the start. So I focused a lot on writing detailed procedures, and refining those over time with the help of my talented team. We also used software—both our own and other software tools—to streamline much of the processes in the service. –
Brian Casel, Founder of Restaurant Engine
3. Customer Metrics
As covered in the valuation discussion above, when it comes to SaaS, metrics are vital to convincing buyers of the strength of the business. Seasoned investors in the space will review MRR, churn, LTV, CAC, retention and your cash burn rate closely. Not sure what those first three are? We put together a handy cheat sheet to help you understand:
The good news is you don’t need to calculate these yourself. The SaaS analytics industry has a number of great solutions for business owners including Baremetrics (for Stripe), ChartMogul (for Stripe, BrainTree, Recurly and PayPal) and FirstOfficer (for Stripe) to name a few. Make sure to integrate these with your merchant processor well in advance of a sale, to capture the relevant historical data before going to market. Note: ChartMogul has a useful tool for loading past data too!
The prospective buyer for your business is not necessarily looking for a job, so if you’re able to reliably outsource tasks to agencies, contractors or virtual assistants, do it. Online businesses that are more passive in nature tend to sell at a higher price than those that involve more work on the owner’s part.
Remember the ‘power of passivity’: it’s a potentially huge value driver for the sale of your business. Owners who can successfully remove themselves from the day-to-day of their business often find that they benefit from a higher valuation once they’re ready to sell.
Virtual assistants can be very useful in this regard and we’ve discussed effective hiring and delegation here.
5. Powder in the Keg
If you’ve done the legwork developing a new feature and creating a marketing strategy around it, it can be worthwhile holding off on releasing before a sale.
The addition of a brand new product or revenues will need 3-6 months of history to move a valuation higher (this is not unique to SaaS businesses). A smarter strategy is often to use this as leverage to gain stronger offers off the existing valuation and get a higher cash consideration upfront. This can often offset the perceived lost profit from delaying the release of the new product or upgrade.
How to Sell a SaaS Business
With the business primed for sale and a solid valuation in mind, it’s now time to turn to your exit options.
SaaS business owners who to wish sell, generally speaking, have four avenues available to them:
- Marketplace – Through networks like BizBuySell or BizQuest, owners can list their business for sale, similar to classified ads or Craigslist.
- Auction – See which buyer will bid the highest through this platform.
- Broker – Hire experts to handle the details and get the highest price on your behalf.
- Direct – Take the cold approach and handle the details yourself.
Each approach has its pros and cons. Let us break them down for you:
Selling your SaaS business on a marketplace means preparing information on your business and posting a listing in order to generate interest from buyers that peruse the listings. A popular marketplace is BizBuySell.
- Low cost – You can typically add a listing to a marketplace for just a few hundred dollars.
- Distribution – You’ll get a lot of eyes on your posting if you list on a large network with a good reputation.
- Low demand – Marketplaces serve a high volume of listings daily and standing out from the crowd is often a problem. Most buyers perusing the listings look for listings with brokers (who use them as well) as they know the listings are likely pre-vetted. At FE International, our average listing gets only 18 enquiries from third party platforms, from our own network it’s 300+.
- Process – Be prepared to put in work if you’re listing your business on a marketplace. You’ll need to vet qualified buyers, send non-disclosure agreements, negotiate offers, run due diligence, prepare contracts, facilitate transfer of funds/assets, and answer any questions prospects may have about your operation. In other words, there’s a lot of room for error if you don’t have experience selling businesses.
- Time – The average marketplace sale takes six to nine months to complete. Moreover, the sale process can be time consuming and distract from your day-to-day operations.
- Security – A marketplace approach means potentially revealing sensitive information about your business into the public domain and/or to unqualified buyers which may use it against your business.
Selling your SaaS business in a marketplace can be a good idea if you have prior experience in the sale process, expertise in SaaS metrics and the time to carry it through. If you don’t, this option is time and work intensive.
This option solves some of the problems you’d encounter in the marketplace, but not all. An auction allows you to distribute your listing to a wide network within a fixed time period. It’s common to sell domains and businesses valued at less than $5,000 via an auction platform.
- Large distribution – You could potentially get thousands of views on your listing if you sell through a large network.
- Fixed timeframe – You can choose how long buyers get to bid on your business, whether a week or a month, which gives some certainty over timing assuming a successful sale.
- Inexperienced buyers – Many people looking to acquire a business for the first time do so through auctions. Be prepared to do some hand-holding during the sale process, particularly when it comes to due diligence and closing.
- Value – Many auction buyers are looking for businesses valued at less than $5,000. The typical multiple for sales via auction is 0.5-1.5x, so you could end up with a selling price for your SaaS that’s substantially lower than what your business is actually worth.
- Process – As above, you are responsible for running the process end-to-end. This is likely going to take up quite a lot of your time.
- Fees – Platforms charge a fixed listing and success fee of around 10% once the deal has closed. This is more than a marketplace fee and about the same as a broker, only you’ll get little support.
- Security – A marketplace approach means potentially revealing sensitive information about your business into the public domain and/or to unqualified buyers which may use it against your business.
If you’re trying to quickly sell a small business and have some experience in the arena, an auction could be a suitable option as long as you’re satisfied with a lower valuation and less secure (more public) process.
Using a broker to sell your business is the best bet if your SaaS business is worth more than $20,000 or if you need expert help managing the details of a sale and getting the best value.
A good broker will facilitate the whole sale process, including developing marketing materials, contacting prospective buyers, negotiating offers, completing due diligence, drafting the contract and coordinating the transfer of assets or funds through escrow. Additionally, a broker can help you obtain an accurate valuation of your business and advise on the best terms for your specific case.
- Large distribution – You’ll benefit from a broker’s network of qualified buyers who have experience in business sales. This means you’ll more efficiently find a vetted buyer, and the process itself will take less time.
- Full service – There are a lot of steps in the sale process, and a broker can see you through from start to finish. Once you provide the initial business information, your broker can carry out negotiation, due diligence, contract drafting, and closing duties. This will save you a lot of time as a business owner.
- Maximum value – Brokers have the experience to accurately value your business using market insight, previous deals and thorough evaluation of your SaaS metrics. They can help you weigh your offers and negotiate to find your best deal.
- Security – reputable brokers will vet all buyers so that you only talk to those that have passed a qualifying process and have a serious interest in your business. Brokers will have tried and tested processes and will use secure data rooms to ensure your IP, data and other key items are securely stored throughout.
- Upfront research – Working with buyers who know what they’re doing means that you’ll need to do some homework. Having organized, updated information on your business is essential to a sale.
- Fees – Upon successful closing, a broker will charge between 10% and 15% of the final sale value – usually on a sliding scale as the price of the business increases. This fee will likely be offset by a higher valuation gained by selling through an expert and the time saved. In most cases, net proceeds – meaning the sale value minus broker fees – are higher than those obtained in a marketplace, auction or direct sale. Here’s a good example of Tim Seidler who sold his business with FE International for $100K more than he thought his business was worth.
Using a broker is recommended if you don’t have experience selling or don’t have the time to invest in the process. Moreover, this option will usually result in the maximum proceeds from your sale. Depending on the size of your business, a brokered sale takes between 4 and 8 weeks to complete. You can read more about how the process works here.
Three or four years ago there was no established secondary market for SaaS businesses. If you wanted to sell your software app you had to go through an auction site like Flippa and sell for 6 – 12 months earnings. These days you can sell through a broker for 3+ year’s earnings and have the process professionally managed.- Rob Walling, Co-Founder of Drip
The final option is to handle the sale on your own. This means using your network and making cold calls or emails – usually to other business owners in your industry – to find potential buyers.
- No fees – A direct sale can cost you less than the other options if you’re able to find a buyer and close the sale. However, you’ll likely end up paying fees for legal advice.
- Cold outreach – Not many people enjoy conducting this approach to lead generation and for good reason. Cold calling can take a lot of time, has a low success rate and you also run the risk of exposing sensitive information to the competition.
- Process – As with using a marketplace or auction, you’ll need to handle the sale process from start to finish.
- Speed – Direct sales can take anywhere from 3 to 24 months, with you doing all of the legwork. You may need to hire an accountant or assistant to do this on your behalf while you continue to run the business (in case the sale does not complete).
- Lower offers – many acquisitions by ‘strategic’ counter parties (e.g. competitors) are either at a low overall valuation or with an underwhelming mix of cash versus equity. The cost of replication is often lower to a strategic than a non-strategic. Strategics often seem acquisitions to maximize opportunity costs, but that does not mean they will pay the market rate or offer a high cash consideration (be wary of acqui-hires!)
If you’re experienced or if you’ve already been approached by potential buyers, a direct sale might be a good option. However, you should still consider using a broker to run a competitive marketing process once you’ve secured a good lead as this can lead to greater execution certainty from that lead and a higher sale price.
Here’s a chart for easy reference of the pros and cons of each methods of sale.
How Do I Determine What My SaaS Business is Worth?
Now you know all about valuation, exit strategy and sale options for your SaaS business, the best way to get a good sense on how much your business is worth is to speak a broker. They will be able to calculate your profit (SDE) accurately and advise on the multiple applicable based on their assessment of the business and previous transactions.
A good broker will give you the best advice on exit strategy and timing, irrespective of whether this is in their short-term interest. The best advice might not be to sell right now, instead to do three things to lift the valuation and come back in 3-6 months with a more valuable business for sale. That’s a win for everybody.