Valuations for SaaS came down in July, but are still high: of the 76 SaaS companies we follow, the average public SaaS business is trading at 9.25x revenue while the median is 8.31x. The data is below.
Negative EBITDA, positive cash flow. The median SaaS business had trailing twelve month revenue of $314mm, EBITDA of -$16mm, but positive cash flow of $20mm thanks to deferred revenue and up-front collections on annual contracts. Indeed so long as you’re growing (the median annual growth rate is 22%), investors will overlook negative EBITDA especially if the business is cash flow positive after working capital changes.
The trend is still strong. The chart below shows median revenue multiples we’ve collected since Q4 2014. During that period, the median SaaS multiple has ranged from 4.43x to 9.32x with an average of 6.55x. Today, we’re at the high end of that range which makes valuations fragile – if you believe in mean reversion, then valuations and more likely to fall in the future.
SaaS margins are still terrible. Investors and founders love saying “SaaS margins are great.” They’re not. They’re horrible. The median EBITDA margin for the companies above was -5% and the average was -6%. Fixed costs for SaaS are terribly high and worse yet those fixed costs are mostly people, meaning the only way to materially cut costs is layoffs. If you’ve ever fired someone, you know cutting costs by cutting people is not easy and hurts the culture and morale of remaining members.
Growth doesn’t explain high valuations. As for growth at 22% YOY, we’d expect stronger growth given these high valuations. 22% is not terrible, but the sector historically has grown at 25% to 30%+. The profitability profile hasn’t changed (the majority of our list is unprofitable as it has always been), so it’s unclear to us why investors are willing to pay 8.31x revenue. The only reason we can think of is that markets in general are overvalued and SaaS is benefitting from investors generally overpaying for companies.
SaaS businesses are healthy. There is almost no debt on these businesses – banks don’t like ‘asset-lite’ businesses like software. Additionally, these companies have $179mm of cash on the balance sheet on median, equivalent to 11 years of burn (recall EBITDA is -$16mm). The number of years of cash on the balance sheet is less important given that these businesses are generally cash flow positive (median of $20mm), and indeed only 15 out of the 76 have negative cash flow. Note that 44 out of the 76 have negative EBITDA, but again that’s acceptable so long as the growth is there and cash flow overall is positive.
Recent IPO’s are killing it. The 4 latest SaaS IPO’s (Docusign, Smartsheet, Z-Scaler, Zuora) are trading at an average valuation of 16.53x revenue. That is borderline non-sensical. It shows that now is a great time to come to market whether you’re raising money or selling the business.
So what’s this data mean for a fast growing private SaaS business? Public multiples and trends tend to guide what’s happening in the private markets: i) as compensation for illiquidity, size, and lack of profitability, prudent investors will look to invest in your private SaaS business somewhere below the 10x average unless your growth rate is demonstrably higher than 22% YOY; ii) financing will continue to come from equity, less so from debt, although we’ve seen banks like Bridge Bank get more aggressive and lenders like Lighter Capital get more creative; iii) and burning cash is still acceptable on an EBITDA basis, so long as free cash flow is positive or moving in the right direction. Finally, given the high revenue multiples, now is an excellent time to sell your business or raise money.