SaaS Valuation Multiples in 2022: What They Are and How to Use Them

After a decade-long increase in SaaS valuation multiples, the upwards trend has reversed course. In 2022, there is more emphasis on profit-based valuation multiples (and the actual costs of profitable growth) versus simple revenue-based valuations of the past several years. There’s also greater variability in valuation between clear market leaders and also-ran products in SaaS categories. In this context, we’re going to review the fundamentals of SaaS valuation multiples so founders are super clear on types of multiples as they analyze their business or look to sell it. What is a SaaS valuation multiple?

We’ve already covered how to value your bootstrapped SaaS company, but how does the multiple play into this?

Valuation multiples are a way to gauge the value of a company simply–based only on one small set of financial metrics.

For example, if you buy a house, you can run a multiple evaluation using Price Per Square Foot. While that’s not the only way to calculate the value of a house, it’s a useful gauge of value.

Other than multiple-based valuations, there are additional ways to determine the value of a SaaS company. Discounted Cash Flow (DCF) is an estimation of all future profits for a business in today’s dollars and SureSwift Capital’s main method of valuation. Most buy-and-hold acquirers like us (it’s our main playbook), will do a detailed projection of the cash flows of a business to help them value it. But, that’s a very detailed analysis going out over a number of future years, whereas the multiple-based approach can help both inform how founders drive value and estimate value relative to other similar businesses based on their performance today.

There are two main types of valuation multiples and both estimate the total value of a company (including owners and any company debt), which is called enterprise value (or EV). EV multiples can be grouped as a function of either:

• Profit multiples — a multiple of the selected profit measurer for a business. This varies depending on the business type, but this includes:
• EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, a measure of a business’s overall financial performance
• SDE, or Seller’s Discretionary Earnings, a financial metric that determines the true historical benefit to the business owner
• Revenue multiples — A multiple of the total revenue of the business. Note: Sometimes SaaS businesses have a mix of recurring revenue and one-time revenue. Recurring revenue is valued at a higher multiple. Revenue multiples miss a lot of the details of the operating structure (and costs) of businesses but can be especially helpful when comparing, for example, SaaS businesses with similar customer bases, lifetime value (LTV), and customer acquisition cost (CAC).

Here are common versions of enterprise value multiples that you may hear:

• EV/Revenue: Commonly used for early-stage or higher growth businesses with no positive earnings. The value of the business is derived by simply multiplying the annual revenue by the multiple.
• EV/EBITDA: Commonly used to compare the relative value of different businesses, particularly larger companies. It’s a ratio comparing a company’s Enterprise Value (EV) to its Earnings Before Interest, Taxes, Depreciation, and Amortization.
• EV/SDE: Commonly used as a benchmark by lenders and prospective acquirers to evaluate the business’s value. It compares a company’s Enterprise Value to its Seller’s Discretionary Earnings (owner’s free cash flow) and is more common for smaller businesses, including bootstrapped SaaS with lower revenue where the founder’s compensation, etc., are removed to give a fuller picture of the profitability for a new owner.

When you look at EV multiples, there are two additional sets of distinctions to help make sure the multiples you use are truly comparable to your business:

1. Public vs Private: Public markets are larger, liquid, and valuations tend to be higher whereas private are typically smaller, more difficult to sell, less liquid, and valuations tend to be lower.
2. Cash valuation vs paper valuation: In the private market, the difference between the cash price (total transfer of risk from the buyer to the seller) and paper valuation is significant. A cash valuation is typically lower than a paper valuation (in which there’s only a small part of the ownership of the business usually seen in venture capital and private equity transactions). SureSwift acquires quickly, cleanly, and in cash, and our deals are typically a complete transfer of the company from a founder to us. More complicated deal structures with only partial transfers usually include more contingencies in determining the value of a deal, and while those contingencies and earnouts can drive a higher value they aren’t certain and often don’t end up being paid.

It’s good to note that two businesses valued (and acquired) at an EV of, say, $10M dollars may return very different amounts to founders. A bootstrapped SaaS founder with 100% of the company and no debt will get the full $10M, but a founder that’s sold half the equity of the company and owes $2M in loans might only receive $4M ($10M EV — $2M debt capital to pay off / 50% ownership in the equity of the business). [And if the founder has sold half of the stock as preferred stock, they could get less than that depending on the details of the preferences for that stock.]

As highlighted above, because these multiples are used to value a company’s entire “enterprise” (the value of equity and debt less cash) rather than just its equity, Founders will often need to adjust the implied EV for certain items to better understand the value of the portion of the business owned by common shareholders. The most common adjustments to EV include a downward adjustment for the market value of debt and preferred ownership and an upward adjustment for cash and cash equivalents.

So, how do multiples impact cash flow-based valuation analysis?

Many acquirers, including SureSwift Capital, estimate the future cash flows from a business to find its value for acquisition. Multiple-based valuation is a nice check on the assumptions in a cash flow-based valuation analysis, and as a result, a shortcut to a rough estimate of value.

Many Founders compare estimates of valuation using simple multiples of revenue, sometimes of SDE. When talking to other Founders, it’s important to know whether the valuation they received was a cash sale or paper deal. If mostly a cash sale, it’s still important to know if there were some earnouts in calculating the total potential value of a deal. Growth rates, profitability, and long-term growth outlooks are huge driving factors of multiples as well.

The Advantages and Disadvantages of Valuation Multiples

Advantages

• Using multiples for valuation analysis is a valuable tool for making investment decisions because they can provide insight into a company’s financial position.
• It’s simple to calculate making it an easy method for relative valuation analysis.
• It’s simple and easy to use in the context of negotiating.
• If performing the analysis correctly, multiples can and should reflect growth.

Disadvantages

• The multiple-based approach often does not fully capture the complexities of owning a business (growth rate, churn, margins, product lifecycle) and can over-simplify a proper valuation.
• Although simpler, a multiple-based approach still relies on a consistent approach to timeframes (Last fiscal year? Trailing 12 months? Annualized monthly performance?) and accounting measures (Gross or net revenue? What adjustments are made for SDE?).
• Multiples simplify complex information into single values which can lead to misinterpretation and oversimplification.

3 Ways to Use a Multiples Valuation When Speaking with Acquirers

1. Ask around about relevant multiples for businesses similar to your business in advance of looking to exit. Being an informed owner helps you frame up your long-term goals if you’re planning for an exit. And it’s good to keep an eye on in case something changes quickly and you decide to sell.

2. Use them to help decide on a potential fit with an acquirer. For example, knowing that you don’t want to sell below 4x ARR (Annual Recurring Revenue) or, say, 4x SDE (Seller’s Discretionary Earnings) is a gateway to deeper conversations with buyers — or not. Credible buyers can quickly know roughly how they’d value a business using their returns models, so it’s a great way to cut to the chase and see if the buyer’s perspective matches yours as a seller.

3. Use them in negotiations. Ask real questions about how an acquirer uses multiples in approaching valuation under deep review for acquisition. At SureSwift, we’re happy to share our math and review with founders when we make an offer. Our returns model focuses on long-term profitable growth — mainly a cash flow analysis — but we can also share what we think are relevant multiples given the characteristics of the SaaS business.

Researching Relevant, Current SaaS Multiples

There are lots of ways to investigate relevant multiples for valuing a SaaS business. Here are a few:

1. Talk to a credible buyer. SureSwift regularly talks to SaaS founders thinking about selling and wanting to get a general sense of the value of their businesses and relevant multiples.
2. Look for current, broad-based research. For example, the team over at SaaS debt firm SaaS Capital puts a lot of work into their overview of SaaS valuations. Although their research doesn’t distinguish between cash and paper valuations and skews a bit high for smaller SaaS businesses in my view, it is still broad-based and super helpful–especially for larger SaaS businesses.
3. Talk to founders with similar businesses who have sold recently. Keep in mind that deal details are usually private. So, founders may not want to disclose anything exact, but asking generally about multiples they saw — and the deal structures (all cash?) to help get a sense of the market. Your sources will be best from founders with businesses similar to yours whom you trust not to shine their own multiples on their exits. A lot of these SaaS founders hang out in communities like Founder Summit and MicroConf.
4. Hire a banker or broker. Any advisor steeped in your space should be able to give you a VERY current and nuanced expectation on the value of your business and likely multiples. Keep in mind that you can get some of this discovery info before signing with a transaction advisor, and once you sign on for help selling, you are firmly committed to that advisor and to share the exit price with them as agreed.

Conclusion

Running a business and selling it is a lot more complicated than simply applying a multiple to one part of its finances. But knowing the right multiples — and what today’s relevant multiples might be because they change quickly — is super helpful for founders whether they are driving value for a future exit or ready for their dream exit today.