Are you an investor, acquiror or a tech business owner? Being able to effectively value a SaaS (Software as a Service) company is a crucial step in understanding its financial health, growth prospects and market position. SaaS companies typically have recurring revenue, high customer retention rates and unique growth potential, therefore traditional methods may not fully capture their true value. So, how should we be valuing them?
1. Revenue Multiples:
This approach compares the SaaS company to similar companies in the industry, using their revenue multiples as a benchmark. A revenue multiple is derived by dividing the enterprise value of comparable companies by their revenue. This multiple is then applied to the target company’s revenue to estimate its value.
When Hubspot decided to IPO, it’s ARR (Annual Recurring Revenue) was around $130 million. Its revenue multiple was approximately 8x.
HubSpot went public with a valuation of $1.1 billion.
What Key Factors do Revenue Multiples incorporate?
- Growth rate (high growth rate = high multiple)
- Profitability (profitable company = higher multiple)
- Market sentiment (bullish market = higher multiple)
2. Discounted Cash Flow (DCF) Analysis:
This approach estimates the present value of a company based on its future cash flows. In DCF analysis you forecast the company’s free cash flows (FCF) for the next several years. These cash flows are then discounted to the present value using a discount rate, typically the company’s weighted average cost of capital (WACC).
What Key Inputs does DCF Analysis incorporate?
- Free Cash Flow (Cash flow after deducting operating and capital expenditure)
- Growth rate (based on historical performance and market outlook)
- Discount rate (Risk of business and capital cost)
Here’s an example:
SaaS Company DCF (Simplified)
Assumptions:
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Year 1 Free Cash Flow (FCF): $5M
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FCF grows 20% per year for 5 years
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Discount Rate (WACC): 10%
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Terminal Growth Rate: 3%
Step 1: Projected FCFs
| Year | FCF ($M) |
|---|---|
| 1 | 5.00 |
| 2 | 6.00 |
| 3 | 7.20 |
| 4 | 8.64 |
| 5 | 10.37 |
Step 2: Calculate Discount FCFs to Present Value
PV=∑(1+0.10)tFCFt≈28.7M
Step 3: Terminal Value
TV=0.10−0.0310.37×1.03≈152.67M
PVTV=(1.10)5152.67≈94.8M
Enterprise Value (EV)
EV=28.7+94.8=$123.5M
3. Customer Acquisition Cost (CAC) and Lifetime Value (LTV) Ratio.
The CAC and LTV are key metrics in SaaS businesses. They focus on the efficiency of customer acquisition and the long-term value a customer brings to the business. CAC refers to the cost associated with acquiring a new customer, including marketing, sales expenses and other related costs. LTV measures the total revenue a customer is expected to generate over the lifetime of their relationship with the company. The ideal LTV:CAC ratio is 3:1, this means that the Value a company generates from a customer should be three times greater than the cost to acquire that customer.
Example: HubSpot 2023.
CAC $6,000 per customer (as of 2023), LTV $45,000 per customer (based on customer churn rate and average customer revenue. CAC:LTV ratio for HubSpot is therefore 0.13, this means for every dollar spent on acquiring a customer, they expect to generate $7.69 in revenue over the lifetime of that customer. This is a very efficient ratio.
Assuming 150,000 customers, an ARPU of $7,000 we can multiple the number of customers by the LTV per Customer to find the total LTV. We then estimate their revenue multiple to be 10x and value them accordingly.
In conclusion, you can use a variety of methods to value a SaaS company, including DCF analysis, revenue multiples and the CAC:LTV ratios. Each provides a different lens through which to assess a SaaS company’s value; however, the right approach can be dependent on the company’s stage of development, market position, growth potential and financial performance.