SaaS: Why lean keeps buyers keen
The heat may have come out of the SaaS market over recent times, but companies with a compelling story built around focused growth can still attract strong investor and buyer attention. Here’s how to achieve that.
Public software company valuation multiples have reduced sharply since the heady days of 2021, which clearly also impacts private businesses in the space. The fall has been greater in the US, where median EV/revenue multiples for US SaaS reached over 11x in the peak, while by the third quarter of 2023, they were down to 6.6x, according to the Silverpeak Benchmark report. In Europe, meanwhile, median EV/revenue multiples declined from 5x at the peak to a more moderate 2.8x in Q3 2023.
The simple fact is that the market has changed and founders are having to prove more to get a deal done. Investors and corporate acquirers are still interested in SaaS companies, but they are being more discriminating and companies must have the right credentials.
This was clear when we attended this year’s SaaStock. Venture capital and growth equity investors continue to back differentiated SaaS businesses and there has been a clear flight to quality. Investors are seeking out companies that demonstrate benchmark SaaS metrics – strong annual recurring revenue growth, SaaS-appropriate gross margins of 75%+, gross and net retention of 95% and 110%, respectively, and positive EBITDA (or a path towards profitability). The same holds true for strategics looking to acquire – they will struggle to get consent for a deal if the business has continued losses.
So how can founders make their businesses stand out for investors and buyers?
- Aim for sustainable growth
In contrast to where the market was in 2021, growth at all costs is no longer acceptable. Instead, investors and buyers are looking for SaaS businesses that can demonstrate respectable, but capital-efficient, growth. These companies are typically disrupting large markets and/or have a genuinely differentiated or specialist product – they are helping customers do something better, more cheaply and more efficiently.
Founders may therefore find they need to bootstrap for longer before seeking initial capital or to extend their runway with existing financing before fundraising again. This is no bad thing because it forces teams to consider their core target market and become more deeply entrenched with their customer base to improve retention rates. That may mean slower growth, but it will be more deliberate and enduring since it comes from customers who see a discernible need for the product in their business.
- Build profitability
Investors and buyers are looking to back SaaS businesses that are either currently profitable or that have a clear path to profitability in the near term. Against today’s uncertain economic background, investors will find it challenging to back a significantly loss-making company with an unpredictable cash runway. Similarly, corporates are likely to shy away from an earnings-dilutive acquisition.
Achieving profitability requires focus. One way of attaining this is to have a product roadmap that is strongly aligned with the customer journey. In the past, when capital was more freely available, many SaaS businesses could hire large engineering teams and sometimes a lack of discipline could lead to a suite of unrelated and disparate products that ultimately suffered from high customer churn.
Today, founders need strong conviction in a core product or products that serve customers’ needs, solve a pain point and are demonstrably critical to them. They also need to be proactively identifying what that customer base will need next, what the future pain points will be and building around these requirements. While attracting new, big-name customers is an important part of any growth story, it is worth keeping in mind that it is far easier and more efficient to sell to existing customers who are loyal, than it is to acquire new ones.
A clear product roadmap that resonates with customers saves on both engineering resource and sales & marketing costs.
- Accept the new market environment
The post-pandemic period of rapid digitalisation led to high buyer and investor demand for SaaS companies and therefore high valuations and large funding rounds. By way of example, the median value for B and C round investments in European technology companies rose by over 90% in the third quarter of 2021 versus the second half of 2020, according to Silverpeak analysis. These fell back through 2022, with Q3 2023 registering median values of €27m series B and €45m series C, a reduction of 30% and 44% from their respective peak.
While it takes time to adjust to lower investment and pricing levels, founders should be clear that these declines were a correction as opposed to an aberration.. Investors and buyers will still pay a reasonable price for high-quality businesses that exhibit the characteristics outlined above, but they are unlikely to overpay unless the business is genuinely differentiated.
- Build a compelling story for the market
Founders who have built a strong, efficient business with sustainable growth and loyal customers that are either profitable or have a clear path to profitability, will naturally want to achieve the highest valuation possible from either a supportive investor or via a strategic sale. That’s why it’s vital to create an equity story, underpinned by the right metrics and data, that resonates with investors and buyers.
A trusted and knowledgeable adviser can help build a narrative that positions a business optimally, taking into account its specific circumstances. These could be to do with the market it operates in, the technology it has built, the moat it has developed, the performance it has delivered, and/or the team that is leading it.
Silverpeak’s experience working with technology businesses and an analytical, data-driven approach to understanding companies and market trends means we can partner with founders to help build strong businesses that attract investor and strategic acquirer attention. We get to the heart of where the value lies in a business and help founders communicate this effectively with potential investors or buyers to ensure they achieve the maximum value in deals that work for all parties.