The world of Software as a Service, or SaaS, is an exciting space to be in. With a robust digital product that solves real-world problems, and a steady income from loyal subscribers, it’s a rewarding journey. However, at some point, you may find yourself contemplating a new venture, or perhaps you’re seeking to leverage the value of the enterprise you’ve built. In those instances, the idea of selling your software company may surface.
Deciding to sell is a significant step, and it might feel daunting. But it’s important to know that it’s a well-charted course and with the right guidance, it can be a smooth transition.
This comprehensive guide aims to equip you with knowledge and insights into the process of selling SaaS business. We’ll explore the nitty-gritty of how to evaluate your business’s worth, prepare it for sale, find potential buyers, and successfully close the deal. Plus, we’ll shed light on what to expect post-sale.
So, whether you’re at the inception stage of your SaaS start-up, or you’re already in the thick of operations and foresee a future sale, this guide will serve as a valuable resource. Remember, selling a SaaS company isn’t an end—it’s an opportunity for new beginnings.
Table of Contents
I. Why to Sell a SaaS Business
II. Understanding the Valuation of Your SaaS Business
III. Preparing Your SaaS Business for Sale
V. Sale Process, Negotiations and Deal Closing
VI. Post-Closing Considerations
Why to sell a SaaS businesses
There are several compelling reasons why entrepreneurs consider selling their SaaS businesses, and understanding these can help put your own thoughts into perspective.
Firstly, selling can offer an opportunity to take your business to the next level. You’ve built a solid foundation, but maybe another entity with more resources, a larger network, or specific expertise can propel it further. It’s not a sign of giving up—it’s about recognizing the potential for accelerated growth.
Secondly, there’s the aspect of risk. Running a software company can feel like a high-stakes game. By selling, you can cash in on your hard work and take some money off the table, providing financial security for you and your family.
Thirdly, as a business grows, administrative and management tasks can take precedence, pulling you away from product development, which might be your true passion. Selling your business can allow you to refocus on what you love—whether that’s honing your existing product or creating something entirely new.
Lastly, personal reasons such as retirement or the desire to pursue other interests often drive the decision to sell. Selling your SaaS business can offer the financial freedom and flexibility to explore new avenues, spend more time with loved ones, or simply enjoy the fruits of your labor.
Understanding the Valuation of Your SaaS Business
Before you dive into the process of selling, it’s crucial to understand what your SaaS business is worth. But how exactly do you put a business value on your tech business?
The most common valuation method for SaaS businesses is the multiples method. With EV/Revenue multiple is used more commonly that EV/EBITDA, as many companies still need to be profitable and still invest in growth. The SaaS business model allows companies to be unprofitable for some time, investing in future growth.
In this method, a company’s value is its revenue times a fixed multiple.
- Revenue used for the calculation is usually Annual Recurring Revenue (or Monthly Recurring Revenue x 12).
- Revenue multiple largely depends on the growth and profitability, but also on other SaaS metrics, the stage of the market cycle, company size and location.
In our analysis of more than 300 transactions, the median revenue multiple in transactions with SaaS businesses stood at 5.2x. There was a significant difference in valuations between companies, with top 25% valued above 9.7x, while bottom 25% below 2.9x.
Importantly, deal size played an important role in determining the revenue multiple, with deals in $50-100M bracket having a median multiple of 6.1x, while smaller $5-20M deals – of only 3.4x.
SaaS Valuation Multiples
Revenue growth and profitability
There are many factors in play for valuation, but the two most crucial ones are revenue growth and profitability. These metrics offer a snapshot of the company’s current cash generation capabilities and forecast the potential for future profit growth.
The sum of these two metrics is also used in a calculation of a so-called Rule of 40. Rule of 40 states that an efficient SaaS company has a sum of profit margin and revenue growth above 40. For public SaaS companies in our analysis, Rule of 40 is an important predictor of revenue multiple with a 10% in Rule of 40 score corresponding to 1.0x increase in multiple.
However, in the SaaS world, other factors come into play as well. In our experience, besides the headline revenue and profit numbers, the buyers tend to look at the following metrics:
- Share of recurring revenue
- Churn rate
- Net Revenue retention
- LTV/CAC (customer lifetime value divided by customer acquisition cost)
- Share of enterprise clients
Lastly, remember the importance of well-kept financial records. Not only do they feed into all these calculations, but they also build trust with potential buyers. If you’ve been diligent in your bookkeeping, you’re already one step ahead.
Valuing a SaaS business isn’t a straightforward task—it’s part art, part science. But by understanding these key factors, you’ll be well-equipped to determine a fair price that reflects the true worth of your SaaS business.
Preparing your SaaS business for sale
When preparing your SaaS business for sale, you must focus on strategic steps to increase valuation, organize your financials and documentation, address legal requirements, and set up a compelling data room. These measures aim to boost your business’s attractiveness and establish a solid foundation for potential buyers.
Strategic Steps for Increasing Valuation
- Time the sales process. Selling a business when it’s at its peak performance is likely to maximize its value. Strong recent growth trends and positive future outlooks make the business more attractive to buyers. Additionally, the macroeconomic environment and industry trends also play a crucial role in determining the optimal time for a sale.
- Optimize Pricing Strategy: Many SaaS businesses undervalue their offerings and resist increasing prices due to the fear of customer churn. However, undervaluing your product can lead to lower perceived value and profitability. Regularly re-evaluating your pricing strategy in accordance with market trends, customer feedback, and the added value your service provides, can significantly boost your revenues. Remember, a small price increase for your existing customers could translate to a substantial increase in your bottom line if implemented correctly.
- Refine Your Sales Strategy. An ideal SaaS business has a healthy mix of customers, including high-value enterprise clients. Often, small and medium businesses heavily rely on self-service sales, but a shift towards more sales-assisted models can open doors to larger enterprise potential customers. These larger contracts not only boost revenue but also increase the average contract value (ACV) and the perceived stability of your income stream.
- Reduce Owner-Dependency: A SaaS business heavily dependent on its owner may be less appealing to potential buyers due to the perceived risks and transition difficulties. Therefore, establish systems and processes that allow the business to run smoothly without your direct involvement. This may involve training your staff for leadership roles or automating certain tasks.
Organize your financials and SaaS metrics
Organizing financials and metrics is a critical part of preparing a SaaS business for sale. You can start by making sure that your financial statements are accurate, up-to-date, and ideally audited by a reputable firm. This includes income statements, balance sheets, and cash flow statements. Financial statements for the past couple of years would be the first thing that any buyer will request from you, they will form the basis for making an offer.
Next, compile your key SaaS metrics such as Monthly Recurring Revenue (MRR), Customer Acquisition Cost (CAC), Lifetime Value (LTV), churn rate, and net promoter score (NPS). It’s important to provide a clear narrative around these metrics, explaining trends and key decisions made. This level of transparency can significantly improve buyer confidence and streamline the due diligence process.
Beyond organizing your financials and metrics, crafting accurate and compelling financial projections is of paramount importance during the sales process. These projections, including revenue forecasts, expense predictions, and estimated growth rates, act as a window into your business’s future, enabling potential buyers to gauge its potential profitability and scalability.
A well-structured financial projection that aligns with your business strategy can significantly boost buyer confidence and demonstrate the sustainability of your growth model. Moreover, these projections can shape the negotiation process, helping you defend your valuation and potentially catalyzing higher offers. However, remember that these forecasts should be data-driven, realistic, and continually updated as your business evolves and market conditions change.
It’s important to note that the sale process for a SaaS company is not a static event, but a dynamic period which can last several months. Throughout this time, the business will continue to operate, acquire new customers, and generate revenues. This means that your key metrics will not stay the same, they will continue to change and evolve. Therefore, it’s crucial to keep these metrics updated during the sale process.
Regular updates will provide potential buyers with an accurate, real-time understanding of the business’s performance. This not only enhances transparency but also shows your commitment to maintain the business’s health, even during the transition period, thereby increasing buyer confidence.
Thorough legal preparation is vital in avoiding potential pitfalls during the selling process. This involves reviewing all contracts, such as customer agreements, vendor contracts, and employee agreements. Also, ensure you have clear ownership of all Intellectual Property (IP) related to your SaaS business. An experienced M&A advisor can help you prepare for this aspect of the sale.
Preparing a Compelling Data Room
A data room is a secure online repository that stores all critical business documents. This includes financial statements, contracts, user data, operational metrics, and anything else a potential buyer might need to evaluate your business.
Preparing a compelling data room not only expedites the due diligence process but also shows potential buyers that your business is well-organized and transparent. A well-prepared data room can be the difference between a smooth transaction and a deal falling through.
In conclusion, preparing your SaaS business for sale involves a combination of strategic, technical, and legal steps. By carefully planning and implementing these measures, you can ensure a successful and profitable sale.
How to Prepare Your Company for Sale
Finding the Right Buyer
When it comes to selling your SaaS business, finding the right buyer is paramount. The ideal buyer should align with your business’s culture, have the necessary financial resources, and hold a strategic interest in your operation. In this regard, Mergers and Acquisitions (M&A) advisors can be an invaluable asset. These professionals have a deep understanding of the market and can help identify potential buyers, handle negotiations, and guide you through the complex process.
Types of Potential Buyers
In M&A transactions, it is common to divide buyers into two groups: strategic and financial investors.
- Strategic Investors: These are typically other businesses within your industry, possibly competitors, looking to gain a competitive edge through acquisition. They value synergies and are often prepared to pay a premium for strategic benefits.
- Private Equity Investors: These buyers are primarily interested in the financial returns your business can offer. They scrutinize profitability, growth potential, and financial stability.
One of the buyer groups specific to SaaS software is vertical software conglomerates (e.g. Constellation Software. They effectively merge the characteristics of both financial and strategic investors.
Like financial investors, they primarily focus on financial metrics in valuation and operate each acquired company standalone. Concurrently, like strategic buyers, they do not have an exit planning and operate the business indefinitely. This dual approach enables them to unlock value in the companies they acquire in ways that other buyers may not be able to achieve.
Strategic vs. Financial Buyer – Which one is right for you?
How to Evaluate the Right Fit
Selecting the right buyer involves assessing their financial capability, ensuring they can afford the purchase and subsequent operation costs. Strategic alignment is equally critical, as the buyer should share your business’s vision and growth plans. Lastly, cultural compatibility should not be overlooked. The buyer should resonate with your company’s culture and values, ensuring a smoother transition for your team and customers post-sale.
Sale Process, Negotiating and Closing the Deal
Navigating the complex waters of a SaaS business sale involves many stages, each with its own significance and challenges. It’s in these phases where an M&A advisor’s expertise becomes invaluable.
The process often begins with a ‘teaser’ – a brief, anonymous document designed to pique the interest of potential buyers without revealing the identity of your business. This document will typically highlight key selling points and attractive metrics while maintaining confidentiality.
Next is the Information Memorandum (Info Memo), a detailed document that provides comprehensive information about your business. It covers everything from company history, product descriptions, and market analysis to financials, key metrics, and future projections. The Info Memo is the primary document potential buyers will use to evaluate your business.
Following the Info Memo, there’s usually a Q&A phase, where interested parties can seek clarifications and more information. Your M&A advisor will help manage this process, fielding questions and ensuring that all communication supports the overall negotiation strategy.
A significant milestone in the deal-making process is the Letter of Intent (LOI). This is a document that outlines the buyer’s intention to purchase your business, including the proposed price and terms. While not legally binding, an LOI signifies serious intent from the buyer and allows both parties to move forward with more detailed negotiations.
Upon acceptance of the LOI, the buyer will initiate the due diligence process. This involves a thorough review of your business, including financial, legal, and technical aspects. Financial due diligence assesses the financial health of your company. Legal due diligence examines contractual obligations, legal disputes, and compliance with laws and regulations. Technical due diligence involves a deep dive into your software, including its architecture, codebase, and scalability.
The closing stage involves finalizing the Sale and Purchase Agreement (SPA), and arranging the payment through a secure method like an escrow service. Your M&A advisor, working in tandem with your legal team, ensures all these steps are completed smoothly and in your best interest.
Throughout these stages, your M&A advisor plays a pivotal role. They help prepare the teaser and Info Memo, ensuring they are both compelling and accurate. They manage the Q&A process, helping you respond to queries in a way that maximizes perceived value. Moreover, they guide negotiations, leveraging their market knowledge and experience to secure the best possible terms.
After the sale of your SaaS business, there are several key considerations that should be accounted for to ensure a smooth transition and secure your financial future.
Firstly, many deals involve a transition period where the previous owner provides support to the new owner. This typically involves training the new owner or management team, introducing them to key clients or partners, and helping to troubleshoot any challenges that arise in the early days post-acquisition. The length and nature of this transition support period should be clearly defined in the Share Purchase Agreement.
Secondly, non-compete agreements are common in SaaS companies sales. These legally binding agreements restrict the seller from starting a similar business or working with a direct competitor for a specified period of time and in a defined geographic area. While these agreements protect the buyer’s investment, as a seller, it’s essential to ensure that the terms of the non-compete agreement are fair and reasonable, and won’t unduly limit your future career opportunities.
Finally, the sale of a business can have significant tax implications, and you’ll need to engage in careful financial planning to manage your newfound wealth effectively. Depending on your jurisdiction and the structure of your deal, you may face capital gains tax or other tax liabilities. It’s advisable to work with a tax advisor or financial planner who can help you understand the tax implications of your sale, identify strategies to minimize your tax liability, and guide you in investing and managing your post-sale finances.
Selling a SaaS business is a significant undertaking that requires careful planning, preparation, and execution. From understanding the unique characteristics of SaaS business valuation, to preparing your business for sale, finding the right buyer, and navigating through negotiations and the closing process – each step is critical to achieving a successful outcome.
Remember, it’s not only about securing the best price, but also about ensuring a good fit between the buyer and your business, which can set the stage for future growth and success.
If you’re considering selling your SaaS business, or are simply interested in learning more about the process, we’re here to help. Reach out to our experienced team can provide you with the guidance and support you need to navigate this complex landscape.
Tell us about what you want to achieve; we can support you from start to close on your M&A journey.