Software as a Service startups, or SaaS, are growing at a steady rate in the U.S. In fact, revenue for these types of companies is expected to grow 17% in the next year. With a total revenue of $85 billion for both private and public SaaS companies, investment in this industry tends to exceed most other sectors. 

 

Potential Investor Valuation

 

SaaS companies need significant investment capital to continue growing. In order to attract potential investors, a favorable valuation is essential. A favorable valuation gives a sense of credibility to a company and instills confidence in the success of the company with future investors. The valuation of a SaaS company is at the core of investment negotiations, so understanding and marketing that valuation is critical to securing a deal with investors. Independent advisory firms may be used to analyze and report the valuation of a company.

 

Early Stage Valuations

 

Established SaaS companies offer more solid factors that can be used for valuation. The history of performance allows for accurate assessments of valuation. In newer start-ups, the methods for determining valuation are more subjective. 

 

Late Stage Valuations 

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Established startups offer investors a financial history to use for their valuation assessment. Having a track record allows for a more accurate prediction. Pre-money valuation is considered the value of a business before capital financing. Post-money valuation is considered the value after obtaining capital financing. 

 

Valuation Based on Company Comparison

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This process of determining valuation is  done by comparing a similar company to the one that you are looking to value. There are a number of aspects to consider and compare. The measure of value of a company including any debt is considered the enterprise value. This can be a good measure of comparison when assessing value. 

Venture Capital Method

 

This “venture capital” method involves following steps:

 

1. Determine the estimated size of the market opportunity based on the total addressable market (TAM).

2. Estimate the market share to calculate revenue.

3. The revenue estimate is applied to a prediction of estimated costs and profitability.

4. An earnings multiple is then used to calculate a future exit price.

5. The future exit price is divided by the desired return on investment.

 

Cash Flow Valuation 

 

This method is based on a discount rate, or the rate of return desired by the investor. The discount rate is an estimated cost of financing a business.

Determining the valuation of a potential start-up requires estimating growth in a particular market and calculating future monthly revenue. Revenue retention as it relates to

churn is critical to SaaS companies.

 

Retention and Churn

 

Retaining customers and the revenue they generate is perhaps the most important factor of generating valuation. It often takes a large number of resources to secure new customers.  

 

When customers are lost, the result is churn. This leads to decreased revenue overall. When a company experiences churn, growth depends on securing new customers to make-up for the loss. As a result, emphasis must be placed on the retaining current customers.