If you’re going to sell your SaaS startup, you’ll need a professional valuation. Your buyer will likely insist on it at some stage during the acquisition process. But before this happens, you need a reference point to grab buyers’ attention. It doesn’t need to be completely accurate, but an evidence-based guess that gets your foot in the door and keeps it there.
Nothing riles investors more than overvaluation, but you don’t want to undersell yourself either. Valuing SaaS businesses isn’t difficult, but it requires effort. Do your homework and the numbers will speak for themselves. Correctly estimate the value of your startup and you’ll not only attract more buyers, but you’ll negotiate from a position of strength.
We created a free SaaS Valuation Calculator for your convenience. Give it a try after reading out guide here first.
How Do Startup Valuations Work?
Since every startup’s different, there’s no one-size-fits-all methodology that’s guaranteed to give you an accurate number. Valuing your startup is all about measuring its performance now and in the future, which involves more than a little uncertainty. However, all SaaS valuations start with applying a SaaS multiple to current earnings or revenue – so let’s start there.
How to Use Earnings to Value Your Startup
Seller Discretionary Earnings (SDE)
If you own and run a small business, you’ll apply the SaaS multiple to SDE. This is your profit after deducting operating expenses and cost of goods from revenue but after adding back in your compensation. Here’s a quick formula to calculate your SDE:
SDE = (Revenue – Operating Expenses – Cost of Goods) + Your Compensation
Why add your compensation back in? Simple, if you’re taking the lion’s share of responsibility, you’re probably taking a lion’s share of the profits as compensation and enjoying the capital and tax advantages of being a small business owner. Adding owner compensation into SDE therefore gives a truer measure of earnings potential.
Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA)
But once you’re big enough to employ a management team, things start getting trickier. You can’t add your compensation into earnings as you’re no longer the only one running the show. This becomes a real cost and must be left out of the earnings calculation along with your other expenses. Instead, you’ll apply the multiple to EBITDA.
EBITDA can be calculated in two ways, and as long as you’re consistent (as in not switching back and forth to get the highest number), you can choose whichever results in a truer representation of your startup’s earnings potential:
- EBITDA = Operating Profit + Depreciation and Amortization
- EBITDA = Net Profit + Interest + Taxes + Depreciation and Amortization
How to Value Your Startup Using Revenue
If your EBITDA or SDE is zero because you’re investing heavily on growth, consider applying the SaaS multiple to revenue. It’s pretty common for SaaS businesses to accept short-term losses in return for growth. You might focus on product development and marketing right now, for example, but pull back on these expenses as you scale.
Before choosing revenue, do remember you’ll need to prove to whoever assesses your valuation you’re on target for such growth. To go back to the house of cards analogy, growth is that one card at the bottom that could bring the whole lot down. So reinforce it with projections, market research, and other evidence to back up your valuation.
How to Choose the Right SaaS Multiple for Your Valuation
You can derive SDE, EBITDA, and revenue from a balance sheet in minutes. The SaaS multiple, however, is a lot more complicated. Where earnings is a verifiable number, the multiple takes into account myriad business, market, and performance factors. I won’t go into all of them here. Instead, I’ll focus on the key things you need to determine where your startup fits into a multiple range.
Between Q4 2014 and Q4 2018, Crunchbase reported a median multiple ranging from 4.43x to 9.32x with an average of 6.69x. This was for public SaaS companies only, but it’s a good place to start. Now, you need to establish where you fit along this spectrum. To justify a higher multiple, your startup should:
- run by itself of with very little involvement from you,
- have been operating successfully for over a year (the longer the better), and
- demonstrate growth potential.
You might be able to tick points one and two right away. To tick the third, you’ll need to review some success metrics, including:
Churn measures lost income through net customer losses or downsized commitments. It’s an effective measure of customer loyalty and the quality of the product or service on offer, but for it to be meaningful, you should compare your churn rate with those of the industry to assess if yours is better. The better your churn rate (ideally it’ll be negative), the more upwards pressure on the multiple.
Customer Acquisition Cost (CAC)
Overspending on customer acquisition impacts the value of your business so you want to keep the CAC low. Burning cash to win new customers is a short-lived strategy that often leads to startups failing. Investors don’t want to throw good money after bad, so you’ll need to demonstrate a reason for a high CAC if you want to keep that multiple high.
Lifetime Value of Customer (LTV)
A high LTV might justify a higher CAC or other revenue losses, and is a useful way of targeting customers who offer the best returns. When deciding what multiple to apply to your earnings or revenue, consider churn, CAC, and LTV in tandem for deeper insight. They each play an important role but combined offer a more complete view of your business’s growth potential.
How to Value Your Startup: The Calculation
Let’s review what you’ve read so far. To correctly estimate the value of your startup, follow these instructions:
- Decide which methodology is most appropriate. SDE, EBITDA, or Revenue. If you own and run a small business, SDE will suit in 99% of cases. Choose EBITDA if you’re larger and share operational responsibilities with others or revenue if you’re projecting massive growth.
- Determine an evidence-based multiple. Use Crunchbase or other startup reports to establish a range of multiples for similar businesses to your own. Then decide where you startup fits using success metrics like churn, CAC, and LTV (reviewed in tandem) alongside age and operational demand.
- Apply the multiple to your earnings or revenue. This gives you an approximation with which you can start conversations with buyers. It’s important that you explain how you derived the multiple so that buyers trust the figure. They might challenge your methodology as a negotiation tactic, but since you’ve done your homework, you are in a position of strength.
The more data you have, the better your startup’s valuation can be. Don’t gloss over things you know impact the health of your business and you’ll have confidence in the final figure. You might even find that professional opinion matches yours.