Let me start this post off by saying we invest in SaaS businesses and like the business model. That said, no matter what the business model, we always scrutinize cash efficiency and path to profitability. As discussed in a past post (“SaaS Multiples Are Collapsing”), we adopted Bessemer’s practice of monitoring about 40 publicly traded companies that have a SaaS business model. Recently we looked at those companies profitability and cash flow and the results aren’t that great: they indicate that building a SaaS business is incredibly capital intensive meaning success hinges as much on access to lots of capital as it does on the quality of the product/solution.
Of the 40 companies we monitor, the average and median trailing twelve month EBITDA was -$9mm and -$13mm respectively for EBITDA margins of -13% and -9%. These margins are on mature businesses with median revenue of $252mm and median enterprise value of $1bln, growing on median 29% year over year. Of the 40 companies surveyed, 24 had negative EBITDA margins.
I know what you’re thinking: SaaS businesses tend to be unprofitable yet cash flow positive because of all the deferred revenue generated from annual contracts collected up front for the year. You’re right, but they don’t generate as much cash as one would think. Of the 40 companies monitored, the average and median free cash flow is $103mm and $21mm respectively. In this case, the average is being inflated by Salesforce and LinkedIn, which generate TTM free cash flow of $1.6bln and $806mm respectively (get ‘em Benioff!). Without those outliers, the average falls to $41mm. While that’s certainly respectable, a median of $21mm of FCF on companies doing $252mm of revenue isn’t exactly monstrous, especially for mature businesses with modest growth. When comparing the median $21mm of FCF to the median enterprise value, these business are trading at a whopping 48x free cash flow.
The general mantra tends to be so long as you’re growing really fast, burning cash or generating a small amount of cash is ok, but these companies had average and median year over year growth rates of only 34% and 29%, respectively. In my view, if you’re not generating much cash or you're burning (ratio of no more than 1:1 revenue:burn), you better at least be doubling year over year.
While I do like SaaS businesses, I cannot stress enough how important cash efficiency is, especially in this environment. While product, team, market, etc are all important for success, if you’re building a SaaS business, access to capital is just as important because it’s going to take a lot of cash to get to size.
My data can be found at the link below, all of which is taken from CapitalIQ.