This question was posted on my “ask me” page on my timberry.com site. I can’t promise to answer all the questions I get, but I try, and I’m particularly happy when I get one whose answer might be useful to other people. So here’s a question:
Do you have any idea how to value a SaaS business? Do we use our users, growth in users, revenues, margins, or what? What do investors like to see?
My answer: I’m probably a bit biased on this one because of my position in Palo Alto Software, which publishes our LivePlan SaaS offering for online business planning. But I can’t say I haven’t thought about it. Here’s what I can do to help:
- I really like How should you value a SaaS company, posted a few months ago by Robin Vessey and then edited by Joel Spolsky on OnStartups. Joel knows software. You’ll see there that it’s about a variety of factors, usually done on a case-by-case basis. It’s a combination of baseline revenue multiple, market potential, value of the technology, and what’s needed to take it to the next level. This is a good discussion.
- Notice that Robin and Joel don’t even mention profits or margins. High-tech companies are almost always valued on growth and revenues, not profits. I explained why in profits are overrated here on this blog.
- I read recently that publicly traded SaaS companies are valued at 5-20 times revenues. Publicly traded means that their stock appears for sale to anybody on a major stock exchange, which makes them inherently different from the smaller startups. And, unfortunately for you and me, we smaller private companies take a discount on the numbers of the big companies because we aren’t big and our stock isn’t liquid and we don’t have to publish financial information. Even there, however, it’s still more about growth and revenues than profits. A SaaS company showing strong growth and breaking even or losing a bit does better than a SaaS company with profits and stable.
- Investors vary on revenue vs. growth in users. I’d say that revenue is much better than just growth in free users, but then look at Twitter and Facebook and the like, which got huge valuations first for huge user bases and then only later for revenue models. So that’s debatable. When I read a business plan I mistrust user numbers that aren’t tied to revenues, because that’s too easy.
What really matters is the future. Valuation isn’t what something is worth, but rather what somebody will pay for it. So what really sells, in SaaS, is its future. There’s nothing better for valuation than indicators of growth in paying users, stories that tell about market need, and a team that can push it. And it’s magic. There’s no MBA algorithm that applies.