If you’re a founder at an early stage SaaS startup, you’re always looking for ways to drive higher and higher company valuations, especially as you move from one round of funding to the next.
At Lighter Capital, we don’t rely on valuations in our financing model, but we thought it would be useful to talk about valuations as they relate to SaaS companies, because they help founders manage their cash runway to achieve long-term sustainable growth.
Before we can dive into steps you can take to increase your startup valuation, we need to break down common business valuation techniques and the variables they use.
While there are many startup valuation methods, one of the most prominent methods used for SaaS startups is the multiples method. With the multiples approach, a multiple is applied against a company metric, like revenue, for example.
Below we explore how SaaS multiples are determined.
SaaS Revenue Multiples
If a SaaS company is growing, but showing a net loss, then revenue multiples are the next best consensus method of valuing a SaaS business. Using this method, a multiple (typically somewhere between 4x and 6x per a recent Techcrunch post) is applied to your company’s most recent trailing twelve months of total revenue.
A number of factors can affect the multiple a company receives.
This can include things like potential market share and total addressable market size based on the product or service provided. Think CRM software for wet shaving e-tailers (niche) versus something that has a large potential customer base, like a ride-sharing service.
If a competitor sells or IPOs, this can be a good indicator of the expected revenue multiple similar companies would receive.
The higher the revenue growth rate, the better the multiple a company will typically see on its valuation. This means that a high flyer can usually punch above their weight class in terms of their multiple.
Since growth rates are expected to flatten as a company reaches maturity, a compound annual growth rate (CAGR) is often used to smooth out these varying rates. If your company is growing at a faster and faster pace, then you could expect a larger CAGR. Alternatively, if you’ve seen significant growth in the last few years, but that growth rate has started to decay, you may see a lower CAGR used when assigning a revenue multiple to your business.
How Do You Improve Your SaaS Valuation?
Let’s assume your company is small and burning, but you’re seeing steady topline revenue growth. If you’re trying to maximize your multiple, your top priority should be increasing net sales.
This may seem like common sense, but as startups move from the development phase to the deployment phase, they sometimes allocate more resources for add-on development, but neglect sales and marketing. This can cause a great product to languish, because it’s continually tinkered with and under-deployed.
We see this most commonly at companies sitting on a large pile of cash, with no concerns about their runway. While they may be able to burn cash for another 12-18 months, they're growth is too anemic to maximize their valuation.
Investing a bit more now to drive sales will likely be better for your valuation than trying to tack on one more month of runway, especially if your funding round closes before the runway disappears!
You also need to pay attention to the market and what's happening in the world around you. When it’s a buyer’s market, choosy investors can negotiate down your multiple.
The once bubbly tech investing climate recently took a turn, and some think capital fundraising is in for a “long winter.” In a down market or an industry-wide bubble bursting situation, angel investors become more cautious, and they want to reallocate a larger portion of their investment portfolios in safer asset classes while they wait out the storm. So when there’s a flight to safety, these funds dry up pretty quickly.
Institutional investors and funds are committed to keep deploying capital as their investment funds are usually geared towards longer holding periods, and they have dedicated pools of capital they need to put to work. So they tend to ride out the storm.