How is a SaaS valuation done?

6 min readJul 17, 2023

SaaS (Software as a Service) has become a technological powerhouse, altering the software distribution and use models on which modern businesses rely. Investors, business owners, and other stakeholders all need a firm grasp on how SaaS firms are valued to keep up with the industry’s rapid expansion.

The global SaaS market is projected to expand at a CAGR of 21.9% from 2019 to 2026, according to a report by Grand View Research. The valuations of SaaS companies have skyrocketed as a result of this rapid expansion.

Which SaaS Metrics Matter Most?

Certain metrics are considered crucial when valuing a SaaS company in order to assess its financial performance and growth potential. These metrics can have a significant effect on a company’s valuation because they reveal important information about the company’s health and longevity. The churn rate, customer acquisition cost (CAC), customer lifetime value (LTV), and monthly recurring revenue (MRR) versus annual recurring revenue (ARR) are some of the most important metrics for a SaaS business (ARR). Let’s dive deeper into some of the most critical SaaS valuation metrics.

A SaaS company’s churn rate is an important indicator of how many customers have stopped their subscriptions or canceled using the service altogether within a specified time frame. The valuation of a SaaS business can be negatively affected by high churn rates, which may indicate customer dissatisfaction, problems with the product or service, or ineffective retention strategies.

For example, A 10% churn rate indicates that 10% of a SaaS firm’s customer base has canceled or stopped using the firm’s product or service within the specified time frame. Increasing the worth of software as a service (SaaS) provider requires a focus on retaining existing customers through means like responsive and helpful customer service, fixing known issues, and regular updates.

A SaaS company’s valuation can also be affected by CAC and LTV. A customer’s lifetime value (LTV) is the average revenue they generate as a paying customer, while customer acquisition cost (CAC) is the average amount spent to acquire a new customer. One indicator of a healthy and growing SaaS business is a high LTV-to-CAC ratio, which shows that the company is making more money from each customer than it costs to acquire them.

For example, Having a CAC of $500 and an LTV of $2,000 for a SaaS business indicates that on average, the firm is making $2,000 in profit from each customer, while spending only $500 to acquire them. A SaaS company’s valuation can benefit from upselling, cross-selling, and other methods of increasing the LTV-to-CAC ratio.

Key revenue metrics such as MRR and ARR reveal the consistency and predictability of a SaaS company’s revenue streams. There are two types of subscription revenue: monthly recurring revenue (MRR) and annual recurring revenue (ARR). The value of a company can be affected by a comparison of MRR and ARR, which can reveal the company’s potential to generate recurring revenue.

For example, If a software as a service (SaaS) business generates $50,000 per month in revenue and $500,000 per year in revenue, it is said to have a monthly recurring revenue (MRR) of $50,000 and an annual recurring revenue (ARR) of $500,000. SaaS company valuations can increase with evidence of stable, predictable revenue growth as measured by MRR and ARR.

Gross margin, which measures the profitability of a SaaS company’s operations, and growth rate, which shows the pace of a company’s revenue growth, are two additional important SaaS metrics that may influence valuation. In terms of valuation, a SaaS company is more attractive if its gross margin is high and its growth rate is high. In order to assess and improve these key metrics and increase the value of their business, SaaS companies must have a deep understanding of their target market, industry benchmarks, and investor expectations.

The Valuation Formula: How is SaaS Valuation Calculated?

The discounted cash flow (DCF) method is one of many methods used to determine a SaaS company’s worth. The discounted cash flow (DCF) method is used to calculate the true value of a SaaS business by discounting its expected future cash flows to the present. The formula for determining a SaaS company’s worth using the DCF technique is as follows:

DCF Value = ∑ (CFt / (1 + r)t)

Where:

CFt represents the expected cash flow in year t
r represents the discount rate
t represents the number of years in the future

In the discounted cash flow (DCF) valuation method, the discount rate (r) stands for the required rate of return for an investor. It factors in the financial performance of the company, the risk inherent in the SaaS industry, and the expected return on investment. The discount rate goes up as risk goes up, and the other way around. Several factors, such as the company’s risk profile, growth prospects, and market conditions, must be analyzed and taken into account when estimating the discount rate.

Most Common Mistakes in SaaS Business Valuation:

Because of its specific nature, valuing a Software as a Service (SaaS) company can be difficult and time-consuming. The following are some of the most typical errors made when appraising a SaaS company:

Ignoring MRR, CLTV, CAC, churn rate, and gross margin, are all crucial SaaS metrics.
Lack of caution when using revenue multiples: the price-to-sales ratio may not be indicative of profitability, growth, or other relevant financial factors.
An inflated valuation can be the result of underestimating the churn rate.
Neglecting market size and rivalry has an effect on growth and longevity.
Intellectual property (IP) and technology are often overlooked, despite their potential to significantly increase profits.
Never underestimate the importance of a talented team with relevant experience in your field.
The risk of losing customers due to a lack of diversification in the market or other factors like increased competition or the introduction of new regulations.
Not considering growth potential in the future: scalability, market penetration, and product roadmap.
Shortage of pertinent industry knowledge; a solid grounding in SaaS is required.
Non-adjustment for non-recurring items: one-time expenses or income must be accounted for properly.
Getting expert help is crucial for a precise valuation of a SaaS company.

What Can You Do to Increase the Value of Your SaaS?

There are a few essential steps you can take to boost the worth of your SaaS business. To attract investors, your SaaS business must first:

Show strong financial performance and growth potential by optimizing and improving key SaaS metrics like annual recurring revenue, monthly recurring revenue, lifetime value, churn rate, gross margin, and growth rate.
Make keeping current customers a top priority by listening to their needs, responding to their suggestions, and implementing their suggestions whenever possible.
Efficiently push forward customer acquisition via targeted marketing and sales strategies optimized for channel optimization and cost reduction in customer acquisition (CAC).

With scalability in mind, optimize operations, automate processes, and leverage technology to expand your business as quickly and effectively as possible. To safeguard your innovations and set your business apart from the competition:

Construct a solid portfolio of intellectual property (IP).
Cultivate strategic alliances to increase exposure and take advantage of synergies. Seventh, show that you have an experienced and capable management team that can put your growth strategy into action.

Finally, present a comprehensive and compelling expansion plan that details your business’s strategies, financial forecasts, and market opportunities. Your SaaS business can gain more value and interest from investors if you follow these steps.

How Can I Get My SaaS Business Valued?

Talking to an expert is the best way to get a sense of how much your SaaS business is worth now that you know everything there is to know about valuation, exit strategy, and sale options. Based on their analysis of the business and past transactions, they will be able to accurately calculate your profit and advise on the applicable multiple. Do you want to value your SAAS company? Reach out to our experts and book a consultation today.