The stock markets can be exciting – the valuation multiples for public software companies swing up and down, rising 10x and then falling even faster. These are usually the focus of media attention and are indeed useful for:
To get an idea of overall valuation sentiment, recent buzzwords and investors’ focus (e.g. growth vs profitability)
To time an exit – valuations for software companies feed through to private markets, although with a delay
Yet – for the vast majority of founders – the public software “comparables” are not comparable at all. Their companies commonly:
Generate a few million dollars in revenue, compared to $100M+ ARR for most listed SaaS companies
Are profitable, cannot afford to burn cash for years, investing in revenue growth
- Are registered outside the US
That is why we looked at hundreds of private deals over 2015-2023 to find that:
The median software company changed hands at 16.8x EBITDA and 3.3x Revenue over the past 7 years
The valuations temporarily jumped in 2021 to 6.0x Revenue, but now seem to be returning to the long term mean
Deal size is a critical factor in valuation – the multiple doubles when you move from $5-20M to a $500M+ basket
US registration adds about 4-5x to EBITDA multiple
Private market software multiples
In our report, we look at the multiples for software companies in transactions with disclosed valuations. Out of 37,900 transactions marked as application software in the database, almost 1,900 had disclosed valuation multiples, such as EV/Revenue or EV/EBITDA.
This is not a scientific study – valuation multiples are disclosed only for certain transactions. We believe the analysis gives a good picture of the valuation trends and the most critical factors for valuing software companies.
We looked at how the valuation multiples changed over time from 2015 to 2023, and how the multiples are influenced by deal size and the company’s country.
The two most popular valuation multiples for software firms are EV/Revenue and EV/EBITDA. There are 1,898 transactions with disclosed Revenue multiple and 883 deals with disclosed EBITDA multiples.
We include both on-premise and SaaS companies.
SaaS Valuation Multiples vs On-Premise Software Multiples
In recent years, much emphasis has been placed on valuation multiples of SaaS companies. In our analysis, we do not differentiate between SaaS and on-premise software vendors as the two software delivery models have been converging over the years, and companies utilizing either model are less and less discernible. While SaaS companies have seen higher valuation multiples due to higher expected growth rates and more predictable revenues, the gap has narrowed in recent years as on-premise vendors have shifted to subscription-based models and are pivoting to the cloud as well.
SaaS valuation multiples: 2015-2023
In our practice, we still see that SaaS companies tend to be valued more highly than their on-prem peers. This is because SaaS companies still tend to have less technological debt than their on-premise counterparts and often have better growth prospects.
Average EV/Revenue multiples for software companies
Revenue multiple is commonly used for valuing software companies, as many of them are actively investing in growth, generating little to no profit.
Among 1,898 transactions included in the analysis for which the revenue multiples were available, the median EV/Revenue multiple stood at 3.2x. That number was relatively flat between the year 2015 and 2020, with a jump in yearly 2021 and later decline.
There is a great deal of variability in the valuations. The top 25% software companies were valued at above 6.9x revenue, while the bottom 25% – below 1.6x revenue.
The highly valued software companies typically address large markets, grow rapidly with a clear path to profitability and are able to demonstrate strong SaaS metrics (net revenue retention, churn, LTV/CAC).
The revenue multiple is usually only a proxy for profit. At the end, investors are interested in the cash flow the company can generate in the future. That is why EBITDA multiple is also widely used for software valuation, especially for more mature companies.
Average EV/EBITDA multiples for software companies
EBITDA multiple is widely used for valuing mature companies with slower growth. Companies with geography-specific products or focusing on niche verticals would be typically valued using EBITDA multiple.
In our sample of 883 transactions, the median EV/EBITDA multiple has been 16.6x. The top quartile of the firms transacted at more than 32.1x, while the bottom quarter at less than 10.0x. Lower growth, technological debt, and customer concentration are among common reasons for undervaluation.
Multiples change over time
The private software valuations have been quite stable in the 2015-2020 period. Private SaaS companies changed hands at around 3x Revenue and 14-16x EBITDA.
The exception here is the 2020-2021 period, when investors bid up the prices in both public and private software deals, supported by the availability of capital and low interest rates. The median multiple for a private software company grew to 6.0x Revenue and 23.9x EBITDA in H2 2021. Investors could afford to overpay looking at the impressive public SaaS companies’ valuations.
Even more impressive was the growth in the first quartile: in the first half of 2022 investors paid for 25% best companies more than 50 times their annual earnings.
The sentiment started to change the following year. In early 2022 the Fed began raising interest rates. Interest rates are a major input in any valuation used to discount future cash flows. Suddenly, unprofitable SaaS companies valued at a high revenue multiple became much less attractive.
By Q2 2022, the median EV/Revenue dropped to 5.1x, trending closer to its historic average value of 3x. The decline continued in 2023, as a median transaction multiple declined to 2.0x in H1 2023 – well below the long-term average. The public SaaS valuations experienced even larger boom and bust cycles.
Size effect on multiple
Company size is one of the most crucial factors determining the valuation. Larger software companies consistently get higher valuations per dollar of revenue or earnings. EBITDA multiple grows by 2-3 every time a company moves one notch up the ladder (see chart).
The are a number of reasons for that.
First, most investors have a defined investment mandate. Financial investors typically target a minimum revenue size and investment ticket. Strategic investors need a company to have big enough size to move the needle for its business.
Larger software companies become attractive to a wider base of investors, stirring up the competition and valuation in the sale process.
Secondly, bigger software firms are less risky. They commonly are less dependent on the founders and have a solid management team and established processes. There are just fewer things that can go wrong in a larger business.
Geography effect on multiple
Geography is also highly important in determining the market value of the business.
The US-based software companies are valued more handsomely at 4.3x Revenue or 21.8x EBITDA. American companies are targeting the largest market in the world with massive scaling potential.
The deal size may be a good explanation for the relatively higher value of US companies. The median deal size for US transactions is $232M, compared to $55M for the entire data set.
At the same time, software businesses from non English speaking countries are often local, difficult to internationalize and scale globally. For instance, both French and German software companies are valued at a median of around 2x Revenue.
UK, producing especially many companies in the Fintech sector, has the second largest number of deals but valued at 3.1x revenue.
The Nordic countries remain a software powerhouse, producing many richly-valued businesses, although smaller in size.
Chinese software market seems to be similar to the American with a high population and massive scaling potential.
2023 Software M&A outlook
With growing interest rates and the economy moving towards a recession in 2023, we believe the multiples will continue to decline from the peak in H1 2021 to get back to the long-term ranges of about 3.0x Revenue or 16.0x EBITDA. In hindsight, it is fascinating to see how stable the medians were before spiking in 2020-2021, so a return to the norm is probably on the way. In the first half of the year, we can already observe the significant decline in valuations, with a median EV/Revenue multiple of just 2.0x.
What is more, the median values of 2015-2019 were still recorded in times of unprecedented low interest rates and quantitative easing by the world’s central bank. With the Federal funds rate approaching 5% in 2023, software investors will need to be compensated more for the additional risk, which feeds through to the lower multiples.
In the coming years, the EBITDA multiple will regain its prominence as investors again focus on the cash flow generation potential of the companies. Revenue multiple, while helpful, was a too convenient metric to conceal the lack of earnings for many companies.
As the capitalizations of stock-listed companies have declined, we expect to see much less acquisition activity from public companies. At the peak of the bubble, payment in buyer’s stock was a popular option. We think it has now become more difficult to issue new shares to fund M&A and convince the sellers to take the shares, which are down significantly. Moreover, strategic investors have troubles related to overinvestment in times of pandemic, so they may put on hold acquisition projects.
At the same time, private equity investors raised a lot of capital in 2021-2022, which they still have to deploy. Some financial investors hunt for deals on the public market (e.g. recent take-privates of Zendesk, Ping Identity, Citrix), while others are looking to acquire private companies. We believe PE dealmaking will continue, yet now with much more scrutiny toward business model and profitability. And as a lucrative exit option (IPO) is not feasible, the entry multiples may suffer too.
Long-term Software M&A outlook
Still, as one technological cycle ends, another begins. The next cycle will have its own narrative, buzzwords and winners. One probable catalyst is the rapid development of Artificial Intelligence – technologies developed by OpenAI showed their power and usability for everyday applications, so a whole new generation of companies may be built on this and other new technologies.
While it may take many years to reach the peak valuations observed in 2021, there will certainly be no shortage of interest in new technologies, so software will remain one of the most richly valued sectors.
About Aventis Advisors
Aventis Advisors is an M&A advisor focusing on technology and growth companies. We believe the world would be better off with fewer (but better quality) M&A deals done at the right moment for companies and their owners. Our goal is to provide honest, insight-driven advise, clearly laying out all the options for our clients – including the one to keep the status quo.
Get in touch with us to discuss how much your business could be worth and how the process looks.
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