Adding a little bit of color commentary here (I sold BCC through FEI, the authors of this post):
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.)
This is by far the most useful, most actionable article to come through here in months. Hope we see more like this.
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.
> 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.
Not really. There's plenty of reasons to sell an illiquid asset, such as a growing business, or shares in a company. Maybe you want to buy a house, or you want to put it all in the S&P 500 to be completely passive and have much lower risk. Maybe you just want to swap your company for a yacht and sail around the caribbean for a while.
Thanks Jason, glad you found it useful. You make an excellent point on the "fixing". I usually advise people to do it at least 3 months before a sale (ideally 12 months) to fully benefit from the potential valuation upside of improvements.
I was offered approx. 4X SDE for my SaaS by a competitor but thought it was too low.
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.
Five years is a long time, a lot can happen in five years.
I've made the mistake of not selling an asset fast enough, and that probably cost me $100k-150k (easily!). What might look great today might not in two years.
3-4x does sound reasonable for something that is:
1. Illiquid
2. Taxed as income -> less favourably than capital gains on stocks
3. Requires work, every, single, day
> 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.
Your SaaS business might get hit with a multi million dollar lawsuit tomorrow and go bankrupt because of it - nothing is certain. But you can definitely get 15-20% returns with proper risk management when investing with your own money. And if structured properly, those gains are capital gains, meaning you pay (a lot) less tax.
That's six years, not five. And the annualized return (geometric mean, not mean) is 12.85%, not 16%.
Worst of all, you picked a short outlier period to consider. If you instead look at the trailing ten years of Feb 2006 to Feb 2016, the annualized return is 6.3%, even with dividend reinvestment. And that's without accounting for inflation, making your real return closer to 4.5%.
Bump up to look at the last 30 years and with dividend reinvestment and adjusting for inflation, you get about 7%. I think that's probably a realistic target to shoot for in the very long run (decades).
Good points on the tax benefits, however the S&P historically is about 10% over the long haul. 16% over the past 5 years is irrelevant. I have no control in the S&P.
I have control in my company. I'd rather rise or fail due to myself than say - the market did this.
I max a 401k for tax purposes and do state muni-bonds for safe, decent tax-free monthly dividend income while I decide what current or new business of mine to invest the cash in. The market is basically tax-friendly gambling.
I don't quite grok the 4x either... Let's say you have a well established (5yr), steady growing (20 - 30% YoY), low churn (5% annual) SaaS with significant custom engineering in the back-end (hard to replicate) currently at $1.5m of revenue. Two co-founders earning $140k each, and $250k EBITDA...
I'm not sure you can add back the full $280k to get $530k SDE, but even still why would you sell something like that for $2m? P/E of 8? 1x forward revenue? Is that really the benchmark?
At that scale and growth, P/E of 6-10 and 1-2x forward revenue multiple sounds reasonable.
One thing to keep in mind is the technological risk and market change over next 5 years. Does your cost base guarantee that you keep investing and changing the business so that after 5 years you are at the top of market again?
Products, services and companies come and go. The buyer needs to take into account the risk of you being outcompeted on the market during coming years. Has happened to many smallish B2B SaaS companies.
The buyer also always has a huge risk of transitioning from current founders and management.
Selling at 4x makes sense if you already have another business that you could grow faster with that cash available to invest now rather than later. Especially if your new business has the potential to grow much larger than the old (say 10x or more).
Also, perhaps you believe your time is better spent on the new business, rather than tending the old. This is especially relevant if the business you're selling takes a lot of time to run.
But agreed, if you have nowhere to invest the cash, selling at 4x seems like a bad idea.
I don't think it's wise to pay more for a business than it's generated in profits. So, I'm a little skeptically of buying a site that's only been around 18 months and they want 2.5x profit for last years profit plus what the owners taken out. If it's a fad,trendy, etc or a buy once product(ran out of customers) or highly dependent on one channel like amazon or google ranking your taking a pretty big risk. Also, if the owners putting a lot of time in on the sales and marketing side or operations side and your basically buying a job.
You would be right to be skeptical in that case - often buyers for younger sites have teams already in place or other sites in that particular industry making it less risky. We tend to avoid "trendy" niches or at least make the valuation reflect the trend (or risk associated).
We also take into account owner time in a valuation. 2 seemingly identical businesses would be valued differently if one owner worked 5 hours a week vs. 50 hours a week by another.
I disagree. you could be buying a SaaS for it's technology which could alone be worth a lot of development hours and tested code is very valuable imo vs. rolling out your own.
This of course won't apply to 99% of SaaS which seem to be just CRUD apps wrapped around bootstrap themes with the vanilla $19/month with a free plan.
The more technically complex a SaaS means the problem it's solving is more complex. Lack of sales could mean a business or marketing issue.
I wouldn't mind paying $100,000 for a complete SaaS if the product worked as advertised and the minimum time and development resources needed to replicate it was very high.
This is a good article at covering various business metrics, but I just have two things to add:
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.
My feeling is that a simple revenue multiplier doesn't work as a seed stage business valuation.
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?)
Seed stage businesses are sold based on the dream of growing into VC-backable rocket ships; these businesses are sold on being reliable cash machines. If you're growing at e.g. 20% month-over-month and have $25k MRR, you quite reasonably will get offered valuations in the high single-digit or low double-digit millions for the company. (When you attempt to sell 10~20% of it in a seed round.) The valuation methodology is, essentially, "whatever we can convince 1+ VCs to accept because they're scared that if they don't say yes a competitor will." It's far more sensitive to prevailing sentiment in the VC community and broader tech market than it is sensitive to the exact particulars of the business being partially sold.
If you're growing at 20% year-over-year, you're basically not investable. You're totally salable if the business generates a profit; if one were to throw out $100k per year for that profit (on an SDC basis as discussed in this post), expect the valuation to be $300k to $400k. This is much, much less sensitive to the current headlines on Wall Street.
There's a lot of daylight between $400k and $10 million, right? That's the premium the market places on growth. This is one of the reasons the G word comes up so much in pg's writing about startups. (See http://www.paulgraham.com/growth.html among many other examples.)
Our data is related to outright sales of [generally] self-funded SaaS businesss.
It's not the same as the VC/angel world where they are investing in unprofitable or pre-revenue SaaS businesses based on potential or estimated future cashflows. The multiples we discuss will not apply in these situations and it's really not our area of expertise.
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.
The multiples we discuss are related to SaaS businesses below $5m valuation. Fortune 500 companies are indeed valued differently, usually on a multiple of EBITDA or similar.
10x is very high. Sure, there will be a few deals at that level, but the majority are not. Our data is based on over 50 SaaS sales below $5m we have completed so is not just made up or an "estimation". It's where 90% of SaaS businesses will fall if you want a high degree of certainty when selling.
There are lots of reasons people sell businesses instead of hiring someone to run them:
- to reinvest into other growing businesses
- they are no longer interested in the business (it's not always about money)
- the business is a mental distraction. Sure, you can hire someone but you still have to think about that business
- to benefit from a lump sum of cash now vs waiting 3/4 years, usually at a lower tax rate (capital gains vs income tax).
Multiples are just prices, and prices are set where buyers and sellers agree. Fortune 500 companies are not operated like, or sold like, SaaS companies with $1k, $10k, or $50k MRR. People who buy SaaS businesses for $50k to $5 million generally offer 2~4X. If you think they're really, really worth 10X, start offering 5X and making out like a bandit; I predict you'd become fast friends with a lot of SaaS owners.
The private "small-cap" market is way less liquid and companies are way less valuable according to the market. If you subscribe to FEI's newsletter you'll see that most young SAAS companies are actually finding buyers who are only offering about 2 years profit. It's also a lemon market, which is unfortunate. I recently sold a SAAS and got 2 years profit.
It depends mostly on growth. 10 P/E is OK if you grow 2 x year as a large company or 4-5 x per year as a smaller company. Not if you're a small company growing up to 2 x per year. 10 x earnings means huge growth and potential upside.
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.)