What if I told you that for each dollar you make, you could get $36?
You’d probably think that there is something scammy or illegal behind it…
Yet most tech companies are leveraging this.
And everyone from Alex Hormozi to Iman Gadhzi is talking about it.
So what the hell am I referring to?
Well, I’m talking about SaaS or software as a service.
And in this article, I want to explain how you can turn $1 into at least $36 thanks to the SaaS business model.
What is a SaaS?
If you’re not familiar with SaaS businesses (or software as a service), here’s a quick explanation for you:
Imagine you play video games online instead of buying and installing them on your computer from a CD.
That’s how a SaaS works:
Back in the day, when you wanted to use software, you had to install it on your computer or on a dedicated server.
Now, everything is on the cloud. And to make it simple, the cloud represents huge servers all over the world accessible on the internet.
Meaning that you can use the software without having to download or install anything on your computer.
And it's basically accessible on the internet anywhere and at any time you want.
The only things required?
A computer or a phone and an internet connection.
And without even knowing it, you’re using SaaS products on a daily basis: you can think of Netflix, Spotify, Zoom etc.
And since everything is online and accessible everywhere, it makes the adoption a lot faster.
Let me explain:
Since you don’t have to download and install the software on your computer, you don’t have to worry about whether or not you have enough storage anymore.
Hence, you’re more likely to pay for the tool if it can help you.
Let’s take the example of Spotify.
Back in the day, you needed to download songs to listen to them. And since you had limited storage on your phone or computer, you needed to be extra picky and careful about which songs you downloaded.
Now with apps like Spotify, you can listen to tens of millions of songs in a few clicks.
That’s why the SaaS market is growing so fast.
And that’s also why if you compare SaaS to any other business model, it’s literally the holy grail for founders.
Let me give you some numbers:
Since 2015, the amount of money people spend on SaaS has gone from $31B to $200B.
And Statista (which is a market research firm) predicts that the SaaS market will grow by over $35B by 2024.
How do SaaS business' valuation work?
So why exactly was I saying that you’ll be able to turn each dollar you make into at least $36?
Well, let’s look at how businesses are valued 👇
If you take a service business like a restaurant, the valuation is usually 1 time the annual revenue.
For example, if a restaurant is making $100k in revenue and wants to sell, it’ll sell for more or less $100k.
For agencies, the valuation is usually a multiple of the EBITDA.
What does that represent?
The EBITDA means “earnings before interest, taxes, depreciation, and amortization,”
To simplify, it’s basically a way to measure the profitability of companies.
But for SaaS, it’s a totally different game.
Let me explain:
If we look at the average valuation multiples of private and public SaaS companies, they are valued between 3x and 10x their Annual Recurring Revenue or ARR (which is annual recurring revenue, or the amount of money they’re generating over a year.)
Let me give you an example:
If you have a SaaS doing $10M in ARR and you want to sell it, you’ll be able to sell it between $30M and $100M.
The reason behind the big gap between the two valuations is that the valuation of a SaaS company depends on a lot of factors.
Like the age of the business, the revenue, the yearly growth rate, the market, the industry, the retention and churn rates, the average customer value, etc.
But we’ll see how to calculate it exactly right after.
Before, I want to explain why SaaS valuations are so high when you compare them to other business models.
First, SaaS businesses have extremely high margins due to the fact that the fixed costs are often very low.
The fixed costs correspond to the infrastructure costs (servers), the employee salaries, the license subscriptions, the office space, etc.
For example, when you have a SaaS, since it’s on the cloud, you only have to pay to use the cloud’s servers.
When you have a hardware product, the raw materials of your product, and the costs of manufacturing, of production, of shipping, etc.
Second, the beauty of the SaaS business model is that it’s a subscription model.
This means that you’ll have to pay a specific price every month (or every year) to access the software.
And every single time someone pays for a subscription, your Monthly Recurring Revenue increases.
How can you make $36 with only $1?
There’s an industry standard that says that $1 in MRR is equal to $12 in ARR which stands for Annual Recurring Revenue.
For example, if you’re at $50k in MRR, your ARR is equal to $600k.
And since a company is valued anywhere between 3x to 10x its ARR, it means that when you generate $1 in MRR, you’re actually making between $36 to $120.
Let me explain:
$1 x 12 months = $12
$12 x 3 = $36 OR $12 x 10 = $120 🤯
But - keep in mind that this is a very rough estimation.
How can you estimate your SaaS business' valuation?
To help you estimate more precisely your SaaS valuation, I created a Google Spreadsheet that’ll give you an idea of the range of what your business is worth.
Here’s how I created it:
I took into account that most SaaS are valued based on a multiple anywhere between 3x and 10x their ARR.
And to create the formula, I picked the most important ones (and also the easiest ones to find and calculate):
1- The net retention
This corresponds to the revenue a company keeps from its current customers over time.
It’s calculated this way: ((Starting MRR - Churn - downgrades + expansion) / starting MRR)*100 = net retention in %
If your net retention is above 100%, we see it as positive because you have more customers spending more money on your product than customers churning each month. And this is a super positive signal that your product or service is valuable to them.
If it’s below 100%, it’s negative because it means that you have more customers churning than customers spending more money on your product.
If you want to know how you can resolve the negative net retention problem, I created a video about how to reduce churn for your SaaS:
A positive net retention can increase the valuation, while a negative one will decrease it.
2- The EBITDA
The EBITDA corresponds to the earnings of a SaaS before it has to pay its interest, taxes, depreciation, and amortization.
Like I said before, it’s most commonly used to determine if a company makes a profit or not.
If your EBITDA is positive, your valuation increases because it means your company makes a profit.
If it’s negative, it decreases because it means your company makes no profit (and loses money).
3- Yearly growth rate
It corresponds to the percentage by which your revenue increases over one year.
You can calculate it by doing: (revenue at the end of the year - revenue at the start of the year)/revenue at the start of the year
The higher your year-over-year growth rate is, the higher your business valuation will be.
And if your business’ yearly growth rate is below 20%, your valuation decreases.
4- Age of the business
This factor represents the resilience of your business.
A business under 2 years of age will get a slightly lower valuation than a mature one.
Basically, we consider that the older your business is, the more stable and resilient it is - and the more likely it is to last in the long term.
Let’s check out some examples now.
Let’s say your numbers are:
- $20M in ARR
- 120% in net retention
- $7M in EBITDA
- 50% in yearly growth rate
- And your business is 4 years old.
Your SaaS valuation will be around $170M.
Here, all of your parameters are pretty high - which means that you will have a higher valuation.
Let’s take an example where you’re having difficulties growing your company:
- Your ARR is $1M
- Your net retention is 80%
- Your EBITDA is -$500k
- Your yearly growth rate is 15%
- And your business age is 5 years old.
Your SaaS valuation would be around $2M
The quality of your different financial metrics will impact a lot the price at which you’ll sell the business.
If you want to calculate your SaaS valuation, here's the link to the spreadsheet 👇
If you found this article valuable, I created a lot of other articles on how to grow a profitable SaaS business on this blog!
Peace, love & profit!