M&A activity in the Software-as-a-Service space

How to value your SaaS firm in 2024 and is now a good time to exit?

Growing demand for cloud-based software solutions, as well as advances in generative AI, are fueling strong M&A activity in the Software-as-a-Service industry.

In the UK technology industry, there were 142 M&A deals announced in Q1 2024, worth a total value of £4.64bn.

This blog looks at the SaaS M&A market in 2024, common exit motivations and the bespoke valuation metrics used by experts to determine SaaS firm value.

A ripe market for SaaS exits

The software development industry, expected to generate profits of £4.4bn+ in 2024, has been crowned the 9th most profitable industry in the UK by business intelligence firm IBISWorld. Revenue, they say, is expected to grow at a 5-year compound annual growth rate of 5.3% to reach £41.4bn by 2029.

This bullish atmosphere, driven in part by AI hype, has been conducive to higher-than-average M&A activity, as larger companies seek to acquire early-stage SaaS startups with a competitive, innovative edge. Indeed, Gartner, the B2B technology research firm, has recommended that well-capitalised enterprises acquire SaaS start-ups rather than become their customers.

A report by Solaganick & Co also predicts that deal volume in the wider tech sector will keep climbing throughout 2024 and into 2025, as demand is fuelled by strategic buyers, looking to make use of the technology rather than simply make profit from it.

Some recent high-profile deals have included DocuSign’s acquisition of contract management vendor Lexion earlier this month for $165m. And in April 2024, the social media management platform Hootsuite acquired Talkwalker, a Luxembourg-based artificial intelligence (AI) consumer intelligence and social listening company, for an undisclosed amount.

The market, then, is ripe if you’re looking to exit from your SaaS venture.  

And for SaaS firms, there are many reasons to consider an exit:

Growth bottlenecks

The low-cost, high-volume subscription model of many SaaS firms can quickly lead to a growth bottleneck, as insufficient capital for new hires, marketing or new product development dampens innovation.

The median SaaS startup, for example, spends a staggering 92% of the average first-year contract value solely on acquiring each new customer. This implies that it takes around 11 months for these startups to recover their customer acquisition costs (CAC) before realising any profits from a new subscription.

Market consolidation trends

Market consolidation trends, characterised by larger corporations acquiring promising SaaS competitors, may also be a spur to action, driving valuation multiples higher and creating an increasingly competitive market.

In April, for example, it was reported that San Francisco’s HashiCorp Inc., a leader in cloud infrastructure solutions, was assessing interest from potential buyers amidst increasing consolidation in the software industry.

Niche product offering

An SaaS product may well solve a niche problem within a niche industry, however may not constitute a complete business model by itself. Such a product may well perform better as part of a wider portfolio of SaaS solutions.

For many vertical SaaS companies, the planned end game may always have been acquisition by a larger, horizontal software business with a broader product portfolio.

Operational fatigue

SaaS owners, while well-versed in the technical and creative aspects of product development, may not enjoy running the day-to-day business operations and may wish to take a backseat.

Whatever your reason for considering an exit, valuing your SaaS business will be the logical next step.

Valuation types

When valuing SaaS companies, investors and owners often use different metrics than for non-SaaS businesses, because they typically feature higher recurring revenues versus one-off purchases, as well as higher gross margins because cost-to-service decreases over time. Consideration of renewal or churn rate also plays a role in SaaS valuations.

EBITDA-based valuation

EBITDA models derive value from the company’s ability to deliver a strong cash flow, and since it looks at profitability, SaaS companies turning over under £4m can still realise a high multiplier.

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation

Revenue-based valuation (ARR Multiples)

Annual Recurring Revenue (ARR) is a valuation metric that looks at the sum of subscription revenue for the year, in addition to recurring revenue from add-ons or upgrades.

This is typically used where a SaaS is experiencing hyper-growth (e.g. 50% year-over-year), is not particularly profitable, and has an ARR greater than £1.5m.

SDE-based valuation

Seller Discretionary Earnings (SDE) is a financial metric typically used to estimate the normalised operating profit of SMEs, particularly those with an owner-operator model.

SDE = Revenue – Cost of Goods Sold – Operating Expenses + Owner Compensation

What multiples can you expect?

Valuation multiples are determined by a whole host of factors, including gross margins, scalability/the total addressable market, year-over-year growth rate, owner involvement, value proposition, marketing foundations, company assets and the valuations taking place in the wider market.

However, for SaaS companies, the focus usually narrows in on Monthly/Annual Recurring Revenue and Churn/Renewal rates. For example, SaaS companies servicing smaller businesses will generally command lower multiples due to higher churn rates, while those serving the mid-market and enterprise segment will see higher renewal rates and therefore higher multiples.

For this reason, SaaS net revenue retention (NRR) is also commonly factored into SaaS company valuations because it takes into account customer churn, subscription expansion and subscription cancellations, as well as recurring revenue.

NRR = (Beginning Monthly Recurring Revenue (MRR) + Expansion MRR – Churned MRR) / Beginning MRR * 100

Whatever your reason for selling, it is time to unlock your venture’s potential.