Valuing a SaaS business is one of the most debated topics among entrepreneurs, investors, and advisors. If you’re looking for an accurate valuation, contact us!
To understand how to value a technology business, the first question is whether to use a multiple of SDE, EBITDA, or Revenue.
Stories of high revenue multiples for unicorn software businesses can be confusing when compared to the modest earnings multiples for smaller SaaS businesses. The reality is that different software companies represent different investment propositions, largely based on their size and growth.
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SDE vs. EBITDA vs. Revenue
There are several ways to value a business, but it’s important to know the best method for each type.
- SDE for Valuation: Small businesses valued under $5 million often use a multiple of Seller Discretionary Earnings (SDE). SDE is the profit left after all costs of goods sold and essential operating expenses are deducted from gross income. Owner salaries and dividends can be added back to this profit.
- EBITDA for Valuation: Larger businesses with more employees and management personnel use EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). This method is common for companies valued over $5 million.
- Revenue for Valuation: For software companies, revenue can be a better indicator of future earnings potential, especially for growing businesses. This is because software companies often make significant upfront investments in growth, which are expensed in current EBITDA.
Choosing SDE, EBITDA, or Revenue
To decide which method to use, consider the following:
- Is the business reliant on the owner?
- Are revenues growing less than 50% year-over-year?
- Does the business generate less than $2 million in revenue per year?
If the answer is “yes” to any of these questions, SDE might be the best valuation method. Otherwise, EBITDA or revenue might be more appropriate.
Finding the Multiple
The multiple is crucial and is influenced by various factors related to the business, including sustainability, scalability, and transferability. Factors that impact these core drivers will affect the multiple.
SaaS Valuation Drivers
FE International uses a proprietary model to value SaaS businesses, considering factors like financials, customer acquisition, operations, niche, and customer base. We analyze 80-100 areas benchmarked against 40,000-50,000 data points before arriving at a valuation.
SaaS Metrics that Impact Valuation
SaaS businesses typically fall within the 4x-10x annual profit (SDE) range. Key metrics include:
- Age of the Business: Older businesses with a proven track record are easier to predict in terms of future profit and often receive a premium multiple.
- Owner Involvement: Businesses that require less owner involvement and have a team in place are more attractive.
- Growth Trends: Consistent and modest upward trends in growth are ideal.
- Churn: Customer metrics like churn, lifetime value (LTV), and customer acquisition cost (CAC) are crucial for valuation.
By considering these factors, you can better understand how to value a SaaS startup and determine the appropriate multiple for your business.