How does valuing SaaS companies work? At the core of this process is determining every aspect that contributes to a company’s value. Other attributes that will affect its price include:
Value proposition
Its business model
The industry it belongs to
Assets and liabilities
How it compares with other companies
If you’re making an exit soon, learning about how to value a software company gives you the opportunity to justify your sale price when negotiations begin. Explore how these attributes impact the value in this post.
Key Takeaways
What makes the SaaS business model attractive to business buyers is its subscription-based revenue structure, which creates scalability and growth potential. It provides advantages like consistent revenue streams, simpler demand forecasting, and chances to upsell or cross-sell. In software companies valuation, the key figures include customer acquisition costs (CAC), lifetime value (LTV), LTV:CAC ratio, ARR, MRR, and churn rate. They provide investors with insight into profitability and scalability.
When valuing a SaaS company, a broker or appraiser will look at profitability and growth stage and will choose any of the following methods based on the two attributes: SDE, EBITDA, or Revenue methods. Revenue multiples with ARR as the basis attract buyers like private equity firms because of income predictability. SDE reflects owner-operator benefits, while EBITDA reveals profitability, especially for high-growth firms or those meeting the rule of 40.
Market comparables help value SaaS companies by analyzing similar firms’ valuations, using public SaaS data or recent acquisition multiples for reliable estimates. Micro, mid-market, and enterprise SaaS vary in multiples due to churn and contract stability. Market sentiment, interest rates, and economic trends like inflation impact SaaS valuations.
Understanding the SaaS Business Model
When thinking of the SaaS business model, some of the prominent offerings that come to mind are tools like Adobe CC or ChatGPT. They operate on a subscription-based revenue structure, which gives them solid scalability and growth potential.
Subscription business models provide advantages like consistent revenue streams, simpler demand forecasting, and chances to upsell or cross-sell. To value these businesses accurately, it’s important to understand their key components, value drivers, and how revenue is recognized.
From this business model are key metrics used for valuing the company. Among them that are typically compared are customer acquisition costs vs. lifetime value. Moreover, the LTV:CAC ratio is a standard metric in SaaS for assessing the efficiency and sustainability of customer acquisition strategies. These metrics and the ratio they form delivers insight into the company’s profitability, scalability, and investor appeal.
CAC and LTV are not the only metrics used for valuation—others like ARR, MRR, and churn rate are figures that affect SaaS company valuation.
Key SaaS Valuation Metrics
How to evaluate SaaS companies — believe it or not, this is a hugely debated topic. This is because so much data is needed to arrive at an accurate valuation for a SaaS company. In this section, we’ll discuss the most important metrics. And by most important, we mean the figures that matter most to investors and business buyers.
ARR (annual recurring revenue) and MRR (monthly recurring revenue). Why are ARR and MRR calculated separately? Observe the subscription offerings of some SaaS companies. Some deliver services when the customer pays on a monthly basis. Others offer yearly subscriptions.
ARR and MRR track the same concept, but they cover different timeframes, as seen from their names. Because of this, ARR looks at a wider, long-term perspective on business performance, while MRR helps you detect short-term trends.
Which one to use depends on your business model and customer base. If you’re selling to enterprises with annual contracts, ARR makes more sense. On the other hand, if your customers typically pay month to month, MRR is the more practical metric. It is also ideal for SaaS companies in their early stages of operation.
Churn Rate and Retention Metrics. Churn rate is the percentage of customers a SaaS company loses over a certain period, either monthly or annually. It’s best to align this metric with the same timeframe you use for tracking revenue.
What qualifies as a reasonable churn rate can vary depending on your industry and the type of customers you serve. Experts categorize acceptable percentages differently for Main Street, mid-market, and enterprise businesses.
Churn is closely tied to retention metrics, particularly your company’s renewal rate. Since SaaS businesses depend on recurring subscriptions, many customers are expected to renew their contracts. A renewal rate above 90% is generally seen as a strong indicator of customer satisfaction and long-term value.
CAC (customer acquisition cost). Customer Acquisition Cost (CAC) measures how much a SaaS company spends to win a new customer. The result reveals whether the cost of attracting new users aligns with the revenue they’ll generate over time.
A high CAC can signal that you’re investing more in marketing and sales than you’re earning back from each customer and that the current system is unprofitable.
On the flip side, a low CAC suggests your acquisition strategy is efficient—customers are bringing in enough revenue to justify the investment it took to bring them on board.
It enables you to determine the revenue required to offset both fixed and variable expenses.
Valuation Methodologies for SaaS Companies
Three primary methods are commonly used when it comes to valuation SaaS companies: SDE, EBITDA, and Revenue. Brokers will look at your SaaS company’s profitability and stage of growth to determine the best approach.
How to Evaluate a SaaS Company Using Revenue Multiples Approach
One common approach to valuation SaaS companies is based on Annual Recurring Revenue (ARR). This method uses revenue multiples, where buyers—especially private equity firms—are increasingly willing to pay several times a company’s ARR due to the predictability and long-term value of recurring income. Brokers/appraisers are aware of factors that influence multiple ranges and will apply industry-accepted multiples.
For SaaS businesses in a high-growth phase, a revenue-based valuation is often more favorable than an EBITDA-based one, since rapid growth typically comes with lower short-term profitability.
How to Value SaaS Company Using SDE
Seller Discretionary Earnings (SDE) represents the total financial benefit an owner-operator receives from the business after covering all operating expenses—including salaries, overhead, and software tools—while adding back the owner’s compensation to reflect the true earning potential.
How to Value SaaS Companies Using EBITDA
The main point of EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is to reveal the SaaS company’s profitability.
When a business achieves the rule of 40 or maintains a low customer acquisition cost (CAC), it tends to be especially attractive to buyers using an EBITDA valuation. These buyers, often private equity firms, want to acquire such companies as they generate strong cash flow.
Even SaaS companies with less than $5 million in annual revenue can secure high valuation multiples under this model. In other words, EBITDA can be an effective method for maximizing a company’s market value.
Practical Valuation Process
Valuation of SaaS companies is no different from appraising any other company. As the owner, you still need to prepare the key documents and data needed for valuation and due diligence.
Step-by-step guide to valuing a software company:
The first step in valuing a SaaS company is compiling all relevant financial and operational records, including the following:
Financial statements
Customer contracts
Supplier agreements
Leases
Outstanding loans
Any other obligations that could affect the company’s future profitability
The appraiser will then verify whether the data delivers the whole picture of the company’s present financial standing and future commitments.
Comparing the business with other companies is also part of the software companies valuation. A review of its background, ownership structure, and financial track record will take place. Its historical performance provides context for determining its market position and future potential.
A company’s value is closely tied to its expected future cash flows. To forecast this, the appraiser evaluates the business’s current strategy alongside its historical performance.
Choosing the right valuation approach depends on the purpose of the valuation, the intended basis and premise of value, and the availability of relevant data. In some cases, limited information may also influence which approach is most suitable.
Common pitfalls to avoid during SaaS companies valuation:
Comparing SaaS businesses to public companies can lead to inaccurate valuations; stick to SaaS-specific benchmarks.
Treating all SaaS companies the same overlooks important differences that impact value.
Ignoring factors like churn, growth rate, and owner dependency can distort the true worth.
Market Comparables
In some cases, investors want to know how SaaS companies of a similar nature are valued. Hence, market comparables are used as a valuation method. Through this approach, investors or buyers can estimate a price range for the target company.
Experts agree that public SaaS company valuations are the best place to start when building a private company valuation framework. They reflect the collective judgment of a wide range of investors responding to real-time information. Thanks to the large pool of companies and reliance on audited financials, public SaaS company valuations provide strong, reliable data for comparison.
Investors might also use recent acquisition benchmarks as the basis. In particular, they want to find out the multiples used for these companies. Multiples are valuation ratios that show how much business buyers are willing to pay for every dollar of revenue, earnings, or another financial metric. Analyzing these multiples provides insight into a better estimate of what a private SaaS company might realistically be worth.
Yet another consideration about the market comparables approach is Micro vs. Mid-market vs. Enterprise SaaS valuations. Micro SaaS companies targeting small businesses often exhibit lower revenue multiples due to higher churn, while mid-market SaaS balances growth and stability, and enterprise SaaS commands premium valuations for its scalable, long-term contracts. Selecting comparables that align with the target company’s customer segment helps arrive at the most accurate valuation.
The Impact of Market Conditions
SaaS owners planning to make an exit need to think about market sentiment and timing coupled with excellent SaaS valuation metrics to determine if it’s the right time to sell the company.
Interest rate considerations
According to a Software Equity Group report, with inflation holding at 3.2% and interest rate cuts projected for 2025, SaaS firms are primed to benefit from advantageous economic trends.
The same report reveals that private equity investors spearheaded SaaS mergers and acquisitions last year. They dominated through platform acquisitions and add-ons by PE-backed firms. Strategic buyers maintained consistent involvement, though publicly traded strategic buyers showed slightly reduced activity compared to historical trends. With stabilizing inflation and declining interest rates, public strategic buyers are expected to ramp up participation. The SaaS M&A landscape will be gaining more momentum in the near future.
Economic factors affecting SaaS valuations
SaaS valuations have moderated since their 2021 highs, yet multiples remain stable and are often increasing for high-performing firms.
This year, high SaaS valuations hinge on durability, balanced growth, and strategic readiness, per the Software Equity Group. Key drivers include strong revenue retention, sustainable growth with high margins, and clear AI strategies. Companies excelling in these areas command premium valuations, while others face buyer skepticism.
FAQ
What are the common valuation multiples used for SaaS software company valuations?
Multiples within the SaaS landscape can range from 3x–10x ARR for small businesses and 7x–12x for larger public companies.
What is the 80/20 rule in SaaS?
The 80/20 Rule, or Pareto Principle, indicates that approximately 80% of a company’s revenue is typically generated by only 20% of its subscribers.
When it comes to how to value software companies, what key financial indicators should be considered?
Some of the most important financial indicators used in valuations include the following:
ARR and MRR
Churn Rate and Retention Metrics
CAC
Cost Per Customer
Net Profit Margin
Average Sales Price (ASP)
Cost Per Feature Ratio
Customer Engagement Score
What is the rule of thumb for SaaS valuation?
An established benchmark in the field of SaaS profitability is the rule of 40. For a SaaS company to be viewed as a solid investment, the sum of its percentage growth rate and percentage profit margin should exceed 40%. This is one of the things that investors will look into during the valuation of SaaS company.
Conclusion
Best practices for SaaS company valuation:
Business owners aiming to make an exit within the next few years should start consolidating their financials and operational documentation. Doing so will enable them to arrive at an accurate software company valuation.
Hire business brokers/appraisers who have previously performed a valuation of a SaaS company, so they know which valuation approach and multiples to apply.
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