How to Value a SaaS Business

If you have N products, and ever want to sell any of them, thoroughly decouple the businesses from each other as early as possible. I spent weeks getting BCC moved off of my other business' e.g. CDN accounts, Rackspace account (required a server rebuild), MailChimp account (required an email provider migration of a different project), etc. You don't want to be doing this while you're doing either due diligence or handover -- it introduces technical risk into a project which doesn't tolerate technical risk well.

I'm not one to worry overmuch about costs in the day-to-day operation of my businesses, but several months before selling you want to take a quick look at recurring expenditures and do a purge of any which aren't providing essential business value. Four random SaaS expenditures totaling $200 a month disappear into rounding error of a small SaaS business... but that's ~$10k chewed off the sales price. You want to do this months before the sale to allow time for the numbers to be reflected on your P&L statement and to justify, if asked, "Yep, that isn't actually needed to successfully operate the business."

A surprising thing for me: the market expectation at these valuations is for all-cash or almost-all-cash deals, rather than e.g. significant amounts of seller financing (seller loans buyer money to buy business, collects it and interest over time) or earn-outs (additional payments are due 6~24 months later contingent on the business' performance post-acquisition). If your SaaS is worth e.g. $400k, the expectation in the market is $400k cash or possibly ~$50k or so of financing/earnout and $350k cash. I naively assumed $100k cash and $300k financing would be a common term; it appears this is not the case.

Speculative expenditures in growth which you're not capable of utilizing for e.g. owner bandwidth reasons are a really, really bad idea to buy in e.g. the last year, particularly if those expenditures are recurring. For example, if you're at 50% capacity on your present hosting solution, and you're not growing at 2X a year, I'd encourage a seller to think "Document your understanding of capacity planning and put it in the kit for the new buyer" rather than "Move to a +$1k more expensive hosting solution and solve the scaling problem for the next N years"; that marginal $1k in expenses costs you $40k~$50k out of pocket.

Several of my buddies in solopreneur SaaSland have sold businesses in the last year or so. A common thread among many of the sales is waiting too long to sell. Particularly for those of us with portfolio businesses, an earlier business which was performing decently but not growing w/o manager attention often ended up doing the slow decline into that good night thing for 2+ years prior to finally selling it. This costs both the decline in value of the asset and, additionally, 2+ years of drag on your ability to give all your business cycles to businesses which are working well. (I think substantially all of my similarly situated friends with portfolio businesses would agree that by the time there were four things in the portfolio it was clear one was a great recipient of marginal focus and one was not. Substantially everybody held onto the "not" business longer than they would recommend themselves to have done so in hindsight.)

My takeaway from the article is that you don't really ever want to sell a SaaS business if you don't have something more profitable to replace it with.

If you're growing, you'll easily beat a 4X multiplier by simply holding on to it for a few years. If you're declining or stable, nobody will want to give you a good price so it's almost not worth selling. The best strategy is to either keep at it or coast and milk. Worst case, you're declining/stable and still in the "20-40 hour weeks needed" phase, in which case it might make more sense to simply abandon the thing.

The only thing that changes the equation is having something else so successful that those few hours a week spent on your old thing are just a distraction.

One other thing I notice is that businesses are a lot like houses. If you wait to fix that weak, drippy shower until right before you sell, the only guy who benefits is the buyer. If you fix it today, you get to have nice hot powerful showers every morning from here until you sell. Same with fixing your churn, documenting & outsourcing your first line support, etc. Fix it today and keep the profits for yourself, leaving yourself that much stronger when you do decide to get out.

I felt they should pay even more to get rid of their primary competitor.

I also know what they're up to and their recent strategy benefits their other business but also benefits mine.

I have a hard to acquire customer but have found a way to connect with consistent sources to replace most of the churn with a zero cost of acquisition.

4x was too low for me to pull the trigger. I needed about 8x. Why sell a business at 4x when it's hard to compete with because the customer acquisition and churn is a challenge?

The growth fundamentals aren't as good as other businesses but the risk is much lower. I don't think that is valued enough. Everyone wants to roll the dice on huge growth when 25-50% annual returns are out there, nearly guaranteed for small, auto-pilot SaaS companies.

If I sold at 4x and then said, where can I put that money and get a nearly guaranteed 25% return, I don't think I could find that. That would be risky.

So while 4X may be the upper limit for SaaS valuation metrics like the article states - it's not going to get the deal done for many SaaS companies. And I'm fine with that.

1) Relative valuations can be slippery, and I personally sleep better when I make an investment I am comfortable with on an absolute basis.

2) Most often, success in investments is more dependent on the accuracy of your judgment of the business at hand than on your ability to wield spreadsheets. If you are good at the former, you can be middling at the latter and do well, but generally not vice versa.

For example, how does this work for pre-revenue SaaS startups valued $1M-$5M during seed? Even if they've started generating revenue, much of their value comes from the long-term network effects and potential to create a market (right?)

On average for Fortune500 companies the standard multiple is around 15 times earnings. x20 or so times for Technology. Granted these likely are the dominant player and are much more stable but Saas companies have growth potential that likely exceed such companies.

I think the 4x earnings upper limit is extremely low, especially as there is likely a reason they are trying to buy you out, not just from keeping it relatively stagnant in terms of development and collecting profits. I think at a minimum x10 earnings for a substantial Saas would be the low bar estimation by me.

Lets be reasonable, otherwise you would just hire someone to maintain and just cash in if we are talking about a company like this article is talking about.