Sales negotiation: What is the value of your SaaS company?


Sales negotiation: What is the value of your SaaS company?

I am often asked by entrepreneurs during our initial discussions about the valuation I would assign to their company. Naturally, sellers want to achieve the highest possible price. However, as buyers, we will only agree to the deal if we perceive the purchase price as a realistic market price. Like most other private equity funds, we, as buyers, often think in terms of ranges based on our experience in the buyout market. Only if the valuation falls within these guidelines will we proceed with the deal. Therefore, it is important for entrepreneurs to realistically assess the value of their company in advance.

However, in our experience, this is not always the case. There are various reasons for this. For example, we find that some entrepreneurs base their valuation on the amount they hope to cash out rather than the actual market value. Interestingly, this approach sometimes results in significantly underestimated value expectations. Others may look at the valuations of large publicly traded companies, which are challenging to compare with the buyout market prices of companies in the €5 to €30 million revenue range and are influenced by a multitude of other factors. Another reason is the strong emotional attachment of founders to their company, which can quickly lead to an overestimation of its value.

The most commonly used method for quickly assessing a company’s valuation, which we also use at FLEX, is the multiple valuation method. The company’s value is determined using the following formula

Key figure x multiple = enterprise value

The valuation, however, is much more complex than the formula may initially suggest. Because the multiple must be determined correctly, and various factors must be considered when calculating the key metric. Entrepreneurs who are valuing a company for the first time often find it challenging to make an accurate assessment.

As a partner at FLEX Capital, I deal with the topic of company valuation almost every day. I have summarized what to consider when determining the key metric and multiple for SaaS companies here:

Calculate EBITDA correctly

In established companies, EBITDA is typically used as the key metric to calculate the company’s value. Although EBITDA is a well-defined financial metric, we as buyers often arrive at different results when calculating EBITDA compared to the seller. There are several reasons for this.

EBITDA represents profit without considering interest, taxes, depreciation, and other financing expenses. Since we, as investors, are interested in the company’s operational business, EBITDA is adjusted for non-operational income and expenses, as well as one-time effects. Typical one-time effects include consulting costs for transactions or strategic projects, as well as severance or settlement payments related to legal disputes. However, some companies may use this adjustment of EBITDA to exclude actual operational costs from the calculation. Because even an adjustment of 100,000 euros can lead to a difference in the purchase price of more than one million euros with an EBITDA multiple of >10.

Similarly, as an investor, we exclude grants or capitalized development expenses as income in the EBITDA calculation since they do not represent operational income or, in the case of capitalized self-performance, cash-relevant income.

Regardless of where exactly the differences in calculation lie, they can lead to a significant discrepancy between the valuation expectations of buyers and sellers, which can certainly become a deal-breaker.

The Rule of 40

However, calculating EBITDA correctly is not the only requirement for a realistic assessment of the company’s value, as EBITDA is only the basic metric for enterprise value calculation. Equally important is the correct determination of the multiple. The multiple can vary significantly from company to company and is primarily influenced by the company’s future potential. The Rule of 40 is a commonly used metric to determine this potential, even in the SaaS industry. It adds revenue growth and EBITDA margin. If the value is above 40 percent, as investors, we consider it a healthy business, and valuation multiples are higher than for companies with values below 40 percent. This allows companies with lower EBITDA, due to heavy investment in growth, to benefit from a higher valuation. In specific situations and markets, this trade-off can be the right decision and should be considered in the company’s valuation through a higher EBITDA multiple.

SaaS-specific criteria

In addition to growth and margin, there are other metrics for SaaS companies that we, as investors, use to determine the multiple.

One of these metrics is the churn rate. Since it has a crucial impact on revenue growth sustainability, the churn rate is also an important criterion when determining the multiple.
How we as investors analyze the churn rate in the due diligence process can be read here:

Churn – Deal-Maker or Deal-Breaker

The absolute size of the company is equally crucial. A company with an EBITDA of > €5 million will be valued at a higher multiple than an identical company with only €1 million in EBITDA. On one hand, we assume that a larger company is more stable and therefore less risky. On the other hand, there is usually a larger pool of potential buyers, which can drive up the market price.

However, all these factors must be viewed in the context of the market. The best churn rate won’t matter if the market is too small. In our experience, when the market potential is less than €50 million in revenue, it can be challenging for selling entrepreneurs to find buyers.

Sales or ARR as basic key figure

In addition to EBITDA as the base metric, SaaS companies are increasingly using revenue or Annual Recurring Revenue (ARR) as the base metric in valuation calculations. Revenue multiples are accordingly lower than EBITDA multiples. Especially for younger and/or rapidly growing SaaS companies, it can be beneficial to perform a revenue-based valuation calculation alongside the EBITDA-based valuation. This ensures that SaaS companies that prioritize growth over EBITDA are not disadvantaged in the valuation. In this context, we primarily focus on the dynamics of revenue growth to determine an appropriate multiple.

Many times, I can use these few metrics to establish the valuation parameters by the second conversation with the entrepreneurs at the latest. The final purchase price, of course, depends on other factors as well, such as product quality, market position, and, of course, the negotiation skills of the entrepreneurs.

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*FLEX Capital ist ein Private-Equity-Buyout-Investor mit Spezialisierung auf den Softwaresektor. Wir verfügen über maßgebliche Expertise bei der Unternehmensbewertung in diesem Segment.

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*FLEX Capital is a private equity buyout investor specializing in the software sector. We have significant expertise in company valuation in this segment..