How to Value a Loss-Making SaaS Company

When a good CFO is asked how to value a SaaS company, the first question is usually: “Are we buying or selling?”

There are many ways to value a SaaS company, and the results can differ several times over depending on the method used. Let us take the example below and look at valuation from both perspectives: the seller’s perspective and the buyer’s, or investor’s, perspective.

Assume a company has monthly recurring revenue, or MRR, of 600,000 and a gross profit margin of 50%. ARR is growing by 100% per year, while organic growth is 20% per year. The monthly churn rate is 4%.

At the same time, the company spends 500,000 per month on advertising, 60,000 per month on development of new product functionality, and 40,000 per month on supporting the current version of the product.

It is easy to see that the company is loss-making, so classic profit-based valuation methods are not suitable.

We are selling

When selling a company, it is natural to prefer valuation methods that produce the highest possible value. These are usually methods based on gross revenue.

Let us consider the most common approaches.

Valuation based on an annual revenue multiple

The formula is:

Annual Revenue × Multiple = Company Valuation

To calculate the multiple, a reference table can be used.

In our example, the multiple is affected by the following factors:

• private company: 7.7x;
• growth rate above 75% per year: +2x;
• annual net retention rate below 80%: -1x;
• gross margin below 75%: -1x;
• customer payback period above one year: -0.5x.

Total multiple: 7.2x.

Using this approach, the company valuation is:

600,000 × 12 × 7.2 = 51,840,000

Valuation using a growth-rate multiple

Another approach is to include the growth-rate multiplier:

Valuation = ARR × (3 + GRM × GR)

Where:

• ARR = Annual Recurring Revenue;
• GRM = Growth Rate Multiplier, assumed here to be 2.5;
• GR = Growth Rate.

In our case, the company valuation would be:

600,000 × 12 × (3 + 2.5 × 1) = 39,600,000

The advantages of these valuation methods are obvious: they are relatively simple to use and they produce a high valuation. It is also fair to say that revenue-based approaches are widely used in the SaaS world.

We are buying

Should an investor automatically agree with the valuations above?

Probably not.

Revenue-based methods do not pay enough attention to product margin. The growth-rate multiple approach also usually assumes a gross margin of around 75% and profitability of roughly 33%.

It is also important to remember that customer acquisition cost decreases mainly through organic growth. In any paid acquisition channel, the cost of each additional customer usually increases. Of course, there may be a possibility of finding a cheaper acquisition channel in the future, but that possibility should not be priced into the current valuation too aggressively.

So, what formula is more useful for an investor when valuing a SaaS company?

If we describe the current value of a SaaS company as the profit expected over the company’s assumed life, without additional spending on further promotion and development, the formula can be presented as follows:

EV = 5 × (ARRn × GPM - EX) - ARRn-1 × (ACR - OGR)

Where:

• EV = Enterprise Value;
• ARRn = Annual Recurring Revenue;
• GPM = Gross Profit Margin;
• EX = Expenses required to maintain the product;
• ACR = Annual Churn Rate;
• OGR = Annual Organic Growth.

In our example, the company valuation under this formula would be approximately 11,300,000, or 11,305,568.26 if calculated more precisely.