Software as a Service (SaaS) has matured. Its elder statesman, Salesforce, is worth over $50B and nearly every private software company is now SaaS. The reasons are clear. SaaS businesses have much more certain future revenue than older “perpetual license” businesses, and can therefore grow more reliably. Also, SaaS companies have regularly received very high investment valuations, generally 5-10x revenue, and SaaS is the only model many software investors will invest in.
But reality hits home when SaaS companies look to sell for cash to a strategic buyer. According to Magister’s SaaS Exit Value Analysis (downloadable here), the valuations in M&A exits are regularly 3-5x revenue, half the multiple investors paid for similar size companies.
Why do strategic buyers pay a lower, though still very attractive, multiple of revenue?
- SaaS is no longer new. Almost every sector of the enterprise software market, and almost every traditional enterprise software vendor, are shifting to SaaS. Salesforce is an established enterprise software giant, not the disruptor of Oracle and SAP it started life as.
- SaaS companies lose money longer, and usually need more funding, than traditional enterprise software. Perpetual licenses funded many a software company in the past 20-30 years, since customers paid upfront for several years’ benefit. In a “pay as you go” SaaS model, customers no longer fund the business, and therefore SaaS companies need more external funding, and face greater funding risks, than traditional enterprise software.
- Sub $100m revenue SaaS companies are just not that disruptive in most sectors – The vast majority of SaaS businesses are still below $50m of annual revenue. Hardly any are seen as truly disruptive, since everyone is moving to SaaS. Therefore larger strategic buyers do not feel they have to pay a defensive premium to take an up and coming SaaS vendor off the market to defend their core business from attack.
- SaaS companies are not as stable as everyone thinks – Of course SaaS has much greater future predictability than perpetual, but in reality that is only true for the next 12 months or so. And any SaaS business that botches its next release will find its “guaranteed customer revenue” churning incredibly quickly. What holds for traditional software holds for SaaS; you are only as good as your last release.
- A lot of SaaS companies aren’t fully SaaS – Full SaaS means multi-tenant and single instance (meaning one version which runs multiple customers from the same server). In many sectors, customers require a lot of services, specific customization, actual location of the software on premise, or partitioning of their sensitive data away from other customers. All of this dilutes a pure SaaS model to be something less: maybe the revenue is still monthly recurring, but the business model wouldn’t scale as fast as “pure” SaaS.
Given that M&A valuations trend towards 3-5x revenue, what are the key metrics a SaaS company needs to have to qualify for a $100m+ M&A exit?
- $20-25m+ of run-rate revenues. This measured as monthly recurring revenue x 12, and literally for the current month or quarter only.
- At least 40-50% annual growth rate. The entire group of $1B+ value public SaaS companies is growing at 30-40% annually, based on the Magister SaaS Exit Value Analysis. A much smaller M&A target has to be growing significantly faster, i.e. 50%+ to be viewed as truly “fast growing.”
- Clear potential to achieve $100m+ revenue. Strategic buyers actually don’t care about $20m SaaS companies. They care about building a business that can “move the needle” for their own business and valuation. Normally this requires a clear opportunity to be much bigger, and SaaS companies need to paint a picture of how to get there that is credible.
- Strategic relevance. The smaller the SaaS target, the more it needs to prove it is a critical “piece of the puzzle” a large buyer just does not have, or will find hard to build. It’s not enough anymore to be in a “hot space,” because buyers can create their own SaaS offering given enough time and money. Strategic relevance can be proven by commercial deals; if a larger strategic resells or OEM’s a product, it’s a fair bet that it is relevant.
In reality for many SaaS businesses that raised money at 5-10x revenue, this means an extra 1-2 years to grow into their required valuation. For quite a large number of companies however, it means resetting expectations of exit value to the disciplined reality of the M&A market.
And lets not forget, today’s tech M&A market is as strong as it has been since 2000; it can get a lot more disciplined when share prices drop across the board.
For the majority of private SaaS companies, waiting at the bar for Prince Charming to come along risks drinking alone till the bar closes up.
Posted by Victor Basta @MaExits