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Early-Stage SAAS valuation- VC secrets

July 5, 2021
Company Building

The Jungle team has hundreds of conversations with early-stage SaaS founders each year. Future CEOs, passionate about their businesses, determined to launch the next overnight Asian unicorn.

They always have one question for us… ‘What is the value of my business?’

Here’s a secret for you. There is no magic formula. There is no complex algorithm applied behind the scenes that churn out an exact answer. Basic principles of early-stage business valuation remain true. SaaS usually enjoys very high multiples due to their rapid growth, simple scalability, strong margins & recurring revenue, but arriving at an accurate valuation during the early days of the business could be challenging. This is further complicated if they only have a handful of paying customers or are even pre-revenue. So, company valuations for early-stage Saas companies are really about agreeing on the best estimate with limited information to play with.

It is a matter of both art & science.

In the end, you need to remember one simple thing. That a valuation is a negotiation between the founders & the investors. A process that you & the VC will embark on that considers current performance, how growth might happen & what the endgame looks like.

1) Understanding the valuation range

VCs will look first to establish the valuation range they should consider. Perhaps the simplest way to determine this range is to look at comparables. This means analyzing a basket of comparable public & private companies with disclosed revenue & valuation. From that, we calculate multiples of enterprise value & revenue, in a SaaS context, factor in Annual Recurring Revenue (ARR).

Source: Saas-Capital.com

Bessemer publishes a lot of great tools and trackers on its BVP Nasdaq Emerging Cloud Index. and the Product Led Growth Index published by Openview also provides great insights for Public Product-Led Growth SaaS compared to the broader set of Public SaaS companies. Increasingly we see that PLG SaaS companies trade at a significant premium & this will affect how they value your business.

However, there are other factors that will influence your valuation are:

1a) Valuation for Pre-revenue startups

In the early stages of a SaaS business when the startups are pre-revenue or with very limited revenue, just starting to get initial customers (free or paid), relying purely on ARR is difficult. In these cases, valuation has to be considered against dilution, amount raised and potential growth trajectory and margin (which would impact the exit valuation).

Consider how much capital you will need to hit your Series A milestones, but also how future rounds will play out. Good VCs will want the founders to retain a good amount of equity in order to ensure they stay motivated. The rule of thumb is that early rounds will come with a dilution of 15–25% and lead investors typically want ownership of 10% at the very least. So a good thing to do is to look at how your captable will evolve over time, and do the math of how future rounds can play out.

Remember- The highest valuation is not always the best, as it could be harder to sustain if you don’t get to the right metrics and hit required milestones for the next round. Especially, if the pool of investors that has the appetite to back businesses in your industry is limited. Also, be wary of benchmarking only with valuation and round sizes of other geographies with different market dynamics.

1b) Valuation for different SaaS business models

Your business model can also impact your valuation.

Factoring ad-hoc revenue- It is not uncommon for founders to get creative in how they fuel ongoing expenses & critical R&D initiatives. You might be offering consulting, one-time implementation fees, professional services, or even hardware-enabled SaaS. If this is the case, applying a consistent multiple will not give an accurate reflection of the business’ value since this revenue will have a different margin structure, less or no recurring element. In these instances, VCs will look to apply a different multiple to software vs non-software revenue streams.

‘SaaS with a twist’.- One thing that VCs love is the opportunity to realise extra revenues on top of the core SaaS ones. Typical ways of doing this are by launching either a Marketplace or fintech products/services.

SaaS Enabled Marketplaces, ie combining a tool (the software) with a network/marketplace. This enables businesses to expand their addressable markets and build defensible moats. In such cases, software might even be given for free and revenue comes from transactions and services on the platform and your cut on that GMV (ex: from Shopify to Snowflake, Auth0, or Moglix). Similarly, Saas+Fintech businesses- are software that is reselling or embedding financial products or services (payment, insurance, and lending, payroll etc) to the core software product (ex: Shopify payment, KiotViet).

Such business models are valued generously because they demonstrate the potential to expand their addressable market, build defensible moats & capture a larger share of wallet. It can especially unlock vertical Saas which might otherwise be perceived as a too limited market opportunity in some geographies.

2) Growth trajectory and exit potential

Much of what the business is worth now is determined by what it could be worth in the ‘end’ & VCs will be thinking about this from the word go.

Factor in how much money will you need to get to — say — $100m revenue? What is your margin structure and how fast can you grow and what factors will influence that growth. All these questions impact the fundraising trajectory (how much money the business needs to scale) & along with the exit value which ultimately impacts the current valuation.

Keep in mind the VC will also ask what’s the end game (their exit value) and how much could the company be eventually sold for. The key question to be answered is — how much will this investment return because that will also impact how much they are ready to pay today.

With preparation and the right mindset you will get the best outcome: a fair dilution but most importantly the best long-term partner to join and grow your business.

But do remember, all revenues are not equal and equally valued, growth trajectories and gross margin matter a lot, and your exit potential dictates a lot of what investors are willing to pay now.

Here is some additional reading on startup valuation methods that you might find interesting.

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