“What’s My Company Worth”
I get this question multiple times per week. Often the question arises from the current environment of lofty valuations for public SaaS companies (16.5x average revenue run-rate, according to SaaS Capital), frothy public markets, and the atmospheric valuations of companies like Carvana.
Why are valuations so high?
Investors have become enamored with SaaS/Cloud businesses for good reason. These companies generally charge a monthly subscription or some type of recurring fee, which means they deliver predictable revenue. They often experience low churn. As the cloud model is becoming widely accepted, many SaaS/Cloud companies are also growing revenue very fast. They often have very high gross margins (i.e., their cost of goods sold for incremental customers is very low).
Fast growth, high gross margins, and dependable, recurring revenue makes for an attractive business model. And investors have taken notice.
There are other “macro” factors that are supporting our current high valuation environment:
Market Size - The total addressable market for SaaS is much larger now, providing more confidence that startups can grow to a scale even bigger than previously anticipated.
Digital Transformation - COVID has accelerated the adoption of many SaaS products as companies have been forced to work in a distributed fashion, driving up growth rates.
Interest Rates - With the Fed interest rate effectively at 0%, investors have been challenged with finding asset classes that provide returns, with many willing to pay a higher price to achieve the same outcome.
Money Supply - With so many stimulus dollars flooding the system, and not a corresponding drop in overall incomes, the money has to go somewhere, and many people have put it in the stock market, thereby driving up valuations.
But What About Non-SaaS Businesses?
I had a call a couple of weeks back with an entrepreneur who's built a very impressive business. But he's struggling with how to evolve the business from being perceived as a pure service business into something that's more either tech-enabled or SaaS.
This is a conversation that I have frequently with entrepreneurs. Reacting to the lofty valuations that pure SaaS players are achieving, many entrepreneurs are trying to reconcile their valuations versus pure SaaS, and absorb the implications on the evolution of their business; seeking guidance on how they might allocate resources to evolve their business model from service to tech-enabled service and ultimately SaaS -- to maximize value when they do decide to exit.
Decisions like this can’t take place in isolation from a perspective on how the automotive industry is going to evolve and how to ensure the company's positioning will continue to stay relevant based on the future of Automotive retail.
Given the frequency of these conversations, I thought I’d take a few minutes here to provide some perspective on how buyers value different types of revenue.
Let’s start by recapping the 5 most important metrics for SaaS companies.
Monthly Recurring Revenue
Cost Per Acquisition
Average Revenue Per Customer
Lifetime Value of Customer
If we contrast these metrics across non-SaaS businesses, we can start to see why differences in valuations emerge.
Sales multiples for Service industries typically range from 1.0x to 2.0x revenues, depending upon profitability. Why this stark difference between revenue multiples for SaaS vs. Service companies? In some ways, Service revenue is the opposite of the recurring, predictable, low-churn revenue of a SaaS business.
A simpler way of thinking about the point is to say that SaaS companies have higher quality revenue than other companies. Why not bet on companies that get to keep more of their revenue?
SaaS companies command high multiples because, at scale, their operating margins can be 30-40 percent (or greater) and contribution margins on revenue are usually 80-95 percent.
For entrepreneurs who come from a pure Service business model, they should explore ways to enable their business models with technology, which can drive higher gross margins, but also (ideally) create opportunities for defensible intellectual property in their businesses. All of this will be rewarded with greater valuations in the form of higher revenue multiples.
How do you maximize the value of your business?
I have first hand experience helping entrepreneurs ensure better exits over the past 20 years. Some of my most memorable include:
One entrepreneur who was in the process of selling his company to a large strategic player that I helped navigate through sticky negotiations to deliver the best outcome to the entrepreneur and his team.
One entrepreneur who I helped position to have his proverbial cake and eat it too, by cleaving his business into two parts and selling both to different parties. It’s important for companies to understand how to best to focus their efforts in the near term to assure a much better outcome for them when they do decide to sell.
One entrepreneur who needed the encouragement to stay the course, and focus on key areas of value creation to ensure a much better outcome at exit. This resulted in an outcome two years later that was 5x the value he had on the table just two years prior.
I’ve seen first hand what can go wrong with post-acquisition integration. One of the companies I helped acquire lost their founder/CEO after just six months, due to a number of compounded blunders from the acquiring company’s executive team. Experience has taught me where acquisitions can go sideways, and the best way to protect the entrepreneur and their team to ensure (and de-risk) the best outcome.
One of the acquisitions I oversaw had a founder who became increasingly paranoid as we got closer to final signatures. He was specifically focused on how to structure a deal in a way that achieved his objectives, yet protected his downside/risks. Again, experience allows me to help entrepreneurs think through different scenarios to ensure the best outcome.
How does an entrepreneur leverage different company valuations to their advantage?
I look forward to working with you and your team to ensure that you achieve the best possible outcome on exit, and start taking the steps now to ensure that your company is optimally valuable to the right buyers when you do decide it’s time to exit.