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.
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It's More Than Revenue: 5 Additional Ways To Maximize Your Startup's Valuation
Your startup's valuation is major component of a venture capital investment. Getting the highest valuation you can requires giving up less of your equity — if you are raising capital using equity — which means more money in your future pocket.
In addition to boosting your revenue bottom line, here are five other tips that can help maximize your company’s valuation in the eyes of investors.
1. Experience matters, so build a team that has it
While many believe investors are only interested in backing your product, they aren’t. Almost every time an investor makes an offer, they’re investing in the team's ability to achieve something big. This is why it’s so important you have a top-notch team in place before you approach VCs.
When building your team, you should ask yourself a few questions:
What is your team’s track record?
Do they have experience in the startup space?
Have they had prior successful exits?
VCs are looking for teams with ample experience in your industry’s domain. If that experience is in a leadership position, even better. Although many VCs intend to be involved in steering your company, they are also looking to back entrepreneurs they trust will make the right decisions.
A team that looks experienced and has prior success boosts investors’ confidence, making your company more valuable and making it much easier for your company to get money.
2. Demonstrate traction beyond revenue
Escalating revenues is always a good way to demonstrate traction, but the reality is, when seeking VC money, not every startup is that far along in the process. If you are still in the early stages of tuning your revenue model, it’s important to find other ways to demonstrate how your efforts are increasing momentum and how that growth can be harnessed into future revenue.
There are a variety of ways to show this. In prior times, growth in website traffic was one way to gauge growing interest; but today, site traffic alone won’t cut it. You must combine it with other important metrics, like the sign-up rate, to prove traction.
If you are a freemium business, sign-ups are important but have little value without your engagement rate. If you can demonstrate the growth in users continuing to use your product after 30 or 60 days, this can be a strong indication of your startup’s potential revenue in the future.
Churn rate is another important metric you may want to hone in on. Your sales pipeline may be light as you build out your product, but do your paying customers have exceptionally low churn? A low customer churn rate (CCR) shows VCs that you’ve got a product that people love; now, you just need the money to scale your sales and marketing so you can reach a much larger market.
3. Create milestones and exceed them
Hitting key milestones can be hugely important when generating interest in your company. But, whenever you’re raising money, the type of milestones you choose to promote to prospective investors is even more critical.
Choose milestones that demonstrate growth, leadership, and momentum in product adoption. These might include:
Releasing a product that garnered a stand-out review from an analyst or influencer,
Signing a big-name customer and gaining traction with your customer base,
Reaching the break-even point and becoming cash flow neutral; or
Making a key talent acquisition.
Once you’ve identified the milestones that you feel will matter most to investors, work backwards to build a timeline and budget.
TIP: Don’t be overly aggressive, and always consider that achieving these goals may take more time and money than you initially forecast. Showing a prospective investor that you are aiming high is one thing, but coming up short against the very milestones you set can carry a big downside, and it’s important to keep that in mind.
4. Understand investors' incentives and strengthen your negotiation skills
When you approach investors, remember the entire process is a negotiation. You have something they may be interested in (a future return on their investment), and they have something you may be interested in (upfront capital that can help build a long runway).
The more effectively you understand their position and can negotiate around it, the more favorable your valuation can be. So, what does an effective negotiation with a VC require?
Know the market as best as you can. Doing your homework will not only make you more confident but will also make you more credible. Understanding the valuation of companies or teams that are similar to yours can set a baseline for where you should start negotiations.
Don’t suggest a valuation for your company. There’s a big risk in stating what you feel your company may be worth — the VC may think your company is worth more. While it’s essential you know your market, it’s also important to know your audience by allowing them to tell you their number first.
Work potential investors against one another. If you are able to create a bidding war, you will have more leverage to obtain the valuation you desire.
5. Time your fundraising right
So much of your company’s value is based on how investors see your market and industry right now. Is your market hot? Are investors flocking to your industry? If so, the time to raise money is now.
Hot markets come in waves, and a huge component of startup valuation is based on current investor sentiment. What’s popular today is going to be passé in six months, so it pays to be ready to chase those investment dollars whenever interest heats up.
If you see increasing interest in your space and you want to raise VC money, you need to strike while the iron is hot! Market conditions change all the time — don’t overestimate how long investors may have an appetite for funding companies in your category or industry.
On the other hand, you may need a bridge to your next fund raise if the market hits a downturn, and there are many non-dilutive debt funding options to buy your SaaS startup more time.
Instantly estimate the value of your startup and see what it could be worth with up to $4 million in non-dilutive funding from Lighter Capital.