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5 Drivers of SaaS Valuation: #3 – RETENTION

August 12, 2013

What is the risk the business might actually shrink and fail?

The SaaS Capital team has looked at the financials of literally hundreds of businesses over the years. Almost all these businesses were either SaaS companies or had a very similar recurring revenue business model. Drawing from these experiences, we have put together a list of value drivers every seller should pay attention to as they go about preparing for the sale of their company or their company’s stock (an equity raise). Other nuances of your business will undoubtedly impact valuation, but theses are the broad-based value drivers.

Listed in order of importance, they are:

  1. Growth
  2. Addressable Market Size
  3. Customer Retention
  4. Gross Margins
  5. Customer Acquisition Costs

In this third in a series of blog posts are going to take a deeper look at CUSTOMER RETENTION as a valuation driver.

Customer retention is a significant driver of valuation because it touches upon all the key factors that impact the perceived future cash flows of a SaaS business. High retention increases the size of the business, improves the growth rate of the business, and very importantly, reduces the risk of loss.

Our prior analysis on this topic, which is explored in-depth in our white paper “No Churn: Keep Customers and Improve Your Valuation”, shows that the multi-factor impact of improved customer retention over time can double or triple the value of the company. Buyers and investors will pay extra for businesses they perceive as having little risk of losing customers.

All available public and private data indicates that high growth SaaS businesses are worth 5 to 8 times annualized revenue, and slow growth businesses are only worth 2 to 3 times annualized revenue. So while two SaaS companies could have the exact same bookings rate, higher churn means a slower growth rate (see valuation driver #1 – GROWTH) several years down the road. That difference in growth will have a significant impact on the revenue multiple that prospective buyers will assign to the business.

To learn more, download our white paper “What’s Your SaaS Company Worth?” for an in-depth look at all five valuation drivers and other considerations when conducting a valuation exercise.

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