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:
2. Addressable Market Size
3. Customer Retention
4. Gross Margins
5. Customer Acquisition Costs
In this second in a series of blog posts are going to take a deeper look at ADDRESSABLE MARKET SIZE as a valuation driver.
Valuation Driver #2 – MARKET SIZE
This is a key valuation battleground. Your team must be able to simply and credibly articulate that they will generate large profits in the future. Keeping in mind that small businesses in small markets do not generate large profits, it is the size of your addressable market that establishes the upper bounds of your future profits ... and therefore, your valuation.
For this reason, VC’s and buyers dig deeply into the company’s market size. They want to understand your “total addressable market.” In other words, if you sold all your current products to all the potential buyers of those products, how big would your company be? Investors will not pay a $50 million valuation for a SaaS business in a $100 million market. The upside is too limited.
In our experience, managers and owners do not do a good job framing the market-sizing discussion. This is unfortunate because as operators you are in a much better position to build the case. With a little bit of research, the management team can put together a well-organized addressable market presentation that will generally be accepted by the investor.
Because market size has a big impact on valuation, you might want to consider launching into new markets, new geographies, or launching new products before a sale or investment round. Just a few paying customers in the new markets will allow your company to credibly “claim” the expanded market even though it’s not yet fully developed.
In our next blog post in this series we will take a look at valuation driver # 3 - Customer Rentention.
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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