Software as a service (SaaS), a way of delivering utilities and applications over the internet, offers the possibility of easy global access to a large network of applications without having to purchase and install a software on a single computer. It allows everyone to have access to a large network of software and virtual services by paying a fixed price, usually in form of a monthly payment.
The valuation of a company depends on a large number of factors and elements. Valuing a SaaS business can be even more difficult, given there are more factors to be taken into consideration compared to traditional brick-and-mortar businesses.
Businesses valued under $10 million are usually valued using a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization), which is a measure of company profitability. The balance sheet, the list of assets, intellectual property (IP) and agreements in place also are taken into consideration.
In some situations when valuing a company, advisers and consultants consider the SDE (seller discretionary earnings), which is equal to the revenue left to the company owner after deducting all operating and personal expenses from the gross revenue. A valuation based on EBITDA or SDE helps potential purchasers or investors to understand the cash flow they will receive by running the business.
This approach can be applied only to small companies, given that in larger public and private organization the company structure is more sophisticated, especially when there are strategies to optimize and minimize the tax liability by using creative accounting.
Taking into consideration the small- and medium-sized enterprises (SMEs) – companies defined as businesses with a maximum number of employees of around 250 – we can consider the SDE or EBITDA as the best method to value a company.
For highly profitable companies, it’s useful to use business valuations methods such as comparable market value, asset-based, ROI-based, discounted cash flow (DCF), capitalization of earnings and book value.
For SaaS companies, this can be a significant limitation, given that these companies are usually at the early stage of growth and are reinvesting their revenue back into the business.
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