This way to SaaS: how to maximize the value of a tech company
Posted: Tue Dec 10, 2024 8:19 am
If your company sells software with perpetual licenses, I have good news for you. The SaaS (Software as a service) model could not only apply to your case, but also allow your company to gain value in the long term.
Every business owner needs to think about their “exit strategy.” If your strategy is to find an acquirer within ten years, you’ll want to embrace the SaaS model early.
But beyond this increase in value, integrating the SaaS model into your business could also help you access additional capital allowing you to expand more quickly. All without having to call on external investors who would dilute your participation.
Where to start when integrating the SaaS model into your business?
Now comes the bad news: more often than not, you start by losing money.
Indeed, the SaaS model can involve significant changes to your billing as well as your product to make it easier to use and install.
First, the change in billing is one of the most difficult concepts for many SaaS candidates to accept. Instead of charging a large amount when you close the sale, you will now have to charge small amounts each month.
The exercise could have a negative impact on cash flow in the short term, as each sale will take longer to become profitable for your business, but this strategy can become more lucrative in the long run as it makes it easier to acquire new customers.
All SaaS companies go through the same initial trough, a 12-36 month period where they hold their breath until their first cohort of subscribers becomes profitable.
Second, the vast majority of SaaS are plug and play software that do not require much technical effort to install.
So you may need to modify your software to make it easier to install and use. Given current software developer salaries, this could be a significant expense. However, it should be viewed as an investment, not a major expense.
Getting past the initial low
I’ve seen my share of SaaS-based transformations. Every company goes through the same initial trough, a 12-36 month period where they hold their breath until their first cohort of subscribers and subscribers becomes profitable. I like to call this period “the valley of death.”
Cumulative cash flow for a customer
Enlarge image
Coming out of the “valley of death,” their SaaS model was launched. Their challenge now was to ensure that new subscribers and subscribers consistently outnumbered unsubscribers, creating a snowball effect in revenue.
And you, will you succeed in making your first cohort of subscribers profitable? At what price? Until when? This is where you will need to master certain essential data.
3 Key Ratios for Every SaaS Business
At the heart of any SaaS project are the following ratios:
Average Customer Lifetime Value (CCV)/Subscribers and Subscribers
Customer lifetime value (LTV) is the amount of profit you make from a typical customer over the course of their relationship with you. The longer customers stay loyal to your app, the higher the LTV.
Customer Acquisition Cost (CAC)/Subscribers and Subscribers
Customer acquisition cost (CAC) is the total cost of all marketing and sales activities required to find a customer and convert them into a paying subscription.
The churn rate
Churn rate is the number of customers who cancel their subscriptions over a given period of time. It is an important metric to understand loyalty to your product. If a business has a high churn rate, its growth potential will be increasingly limited.
Typically, a turnover rate of more than 10% is not sustainable in the long term, so it is essential to adopt a rigorous customer retention strategy .
For more information on the main financial ratios that apply to SaaS companies and how to analyze them, I invite you to download our digital guide: Measuring the performance of a SaaS company .
In search of the perfect dosage
These ratios allow you to establish with sufficient nurse database confidence the viability of your model. Keep these ratios in mind at all times: they constitute your dashboard.
As for the monthly price of your service, it will be determined by market research. A price that is too high will make you lose customers, while a price that is too low could compromise your profitability.
Here, we should note the stickiness factor , which will depend on the very nature of your product: for example, a software-as-a-service that is somewhat complex to disintegrate from the customers' system will make them hesitant to unsubscribe. They will have more to lose than to gain by leaving you. Good stickiness therefore helps to minimize your turnover rate. Consider this in your strategy!
Once you know your ratios and set your fair price, you reach the snowball effect mentioned above. Indeed, unlike a service provider who must revive their clientele or find a new one every year, a SaaS company never starts from scratch. It only increases its revenue.
But be careful, I didn't say that it was increasing its profits.
Profitability still postponed
Why does the SaaS model not guarantee high profits? Indeed, to counter the effect of unsubscribes, it is necessary to constantly invest in customer development, the cost of which will be higher than the revenue generated by subscriptions during the first 12 to 36 months. The cycle will have to be repeated infinitely to increase the value of the company.
Once you adopt the SaaS model, you will need to constantly keep an eye on your ratios to ensure that they remain favorable and that the business is gaining value.
You can of course stop or slow down your customer development at any time, if your ambition is not to sell to the highest bidder, but rather to ensure long-term income. However, in the SaaS field, more up-to-date competing companies can always replace you if you stop investing.
For growth models, there is no shortage of buyers. Indeed, SaaS services are popular with large companies that do not necessarily have the agility to create them themselves, but are interested in integrating them "turnkey" into their broader offering to increase their value.
As I announced at the beginning of the article, the SaaS model will make your exit much more lucrative than with traditional service delivery or software sales.
Comparing the value of a SaaS company and a “traditional” company
If your "traditional" income is $ 1.2 million per year with $180,000 in profits, the usual calculation for buyers is to offer you between four and six times the EBITDA , or $720,000 to $ 1.08 million . When the time comes to sell your business, this is what will be left to finance your next project or your retirement.
The same company that was valued on its profits will be valued on its total revenue once it moves to the SaaS model. It will meet the same need in the market with the same type of service, but it will be worth much more .
For their part, SaaS companies have been selling for several years at a value between six and 12 times their annual recurring turnover. These are multiples that are frequently seen in Canada regardless of the sector of activity.
Continuing with our example, we can estimate that the company's recurring revenue would initially be lower. For this example, let's say that revenue would be between $250,000 and $300,000. The company could therefore have a theoretical resale value of $ 1.5 to $3.6 million!
The same company that was valued on its profits will be valued on its total revenue once it moves to the SaaS model. It will meet the same need in the market with the same type of service, but it will be worth much more.
Perpetual License Software Company SaaS software provider
Turnover $1.2M/year $250,000 to $300,000 ( $20,000 to $25,000 /month)
BAIIA $180,000 $0 or negative
Multiple on acquisition 4 to 6 times profit (EBITDA) 6 to 12 times recurring revenue
Purchase offer $720,000 to $1.08M $1.5M to $3.6M
Find the right partners
Have we convinced you? Before you move forward, remember the cash flow issues!
If you don't have the means (and the nerves) to finance your business outright for a year or two, including the development not only of your customer base, but also of your SaaS product (programming, team setup, etc.), you need to find the right partners.
At BDC, we have helped many companies make the leap to the SaaS model. We generally intervene once their digital platform is up and running and they are starting to develop their new customer base.
In addition to financing during the initial revenue trough, we are used to juggling ratios and conducting market research to define the right long-term positioning from the outset.
If your company is just starting out in the technology ecosystem, we can introduce you to specialists and other key players in the sector who can help you get off the ground.
The next sectors suitable for the SaaS model
You might be thinking, "My industry isn't ready for this." I'd say the best opportunities are in the industries that move the least.
In industries where the SaaS model is more prevalent, such as financial services, there is less room for new entrants than in a field like construction, insurance, or healthcare.
Wherever delivery models have not changed for decades, the next SaaS success stories will emerge.
Every business owner needs to think about their “exit strategy.” If your strategy is to find an acquirer within ten years, you’ll want to embrace the SaaS model early.
But beyond this increase in value, integrating the SaaS model into your business could also help you access additional capital allowing you to expand more quickly. All without having to call on external investors who would dilute your participation.
Where to start when integrating the SaaS model into your business?
Now comes the bad news: more often than not, you start by losing money.
Indeed, the SaaS model can involve significant changes to your billing as well as your product to make it easier to use and install.
First, the change in billing is one of the most difficult concepts for many SaaS candidates to accept. Instead of charging a large amount when you close the sale, you will now have to charge small amounts each month.
The exercise could have a negative impact on cash flow in the short term, as each sale will take longer to become profitable for your business, but this strategy can become more lucrative in the long run as it makes it easier to acquire new customers.
All SaaS companies go through the same initial trough, a 12-36 month period where they hold their breath until their first cohort of subscribers becomes profitable.
Second, the vast majority of SaaS are plug and play software that do not require much technical effort to install.
So you may need to modify your software to make it easier to install and use. Given current software developer salaries, this could be a significant expense. However, it should be viewed as an investment, not a major expense.
Getting past the initial low
I’ve seen my share of SaaS-based transformations. Every company goes through the same initial trough, a 12-36 month period where they hold their breath until their first cohort of subscribers and subscribers becomes profitable. I like to call this period “the valley of death.”
Cumulative cash flow for a customer
Enlarge image
Coming out of the “valley of death,” their SaaS model was launched. Their challenge now was to ensure that new subscribers and subscribers consistently outnumbered unsubscribers, creating a snowball effect in revenue.
And you, will you succeed in making your first cohort of subscribers profitable? At what price? Until when? This is where you will need to master certain essential data.
3 Key Ratios for Every SaaS Business
At the heart of any SaaS project are the following ratios:
Average Customer Lifetime Value (CCV)/Subscribers and Subscribers
Customer lifetime value (LTV) is the amount of profit you make from a typical customer over the course of their relationship with you. The longer customers stay loyal to your app, the higher the LTV.
Customer Acquisition Cost (CAC)/Subscribers and Subscribers
Customer acquisition cost (CAC) is the total cost of all marketing and sales activities required to find a customer and convert them into a paying subscription.
The churn rate
Churn rate is the number of customers who cancel their subscriptions over a given period of time. It is an important metric to understand loyalty to your product. If a business has a high churn rate, its growth potential will be increasingly limited.
Typically, a turnover rate of more than 10% is not sustainable in the long term, so it is essential to adopt a rigorous customer retention strategy .
For more information on the main financial ratios that apply to SaaS companies and how to analyze them, I invite you to download our digital guide: Measuring the performance of a SaaS company .
In search of the perfect dosage
These ratios allow you to establish with sufficient nurse database confidence the viability of your model. Keep these ratios in mind at all times: they constitute your dashboard.
As for the monthly price of your service, it will be determined by market research. A price that is too high will make you lose customers, while a price that is too low could compromise your profitability.
Here, we should note the stickiness factor , which will depend on the very nature of your product: for example, a software-as-a-service that is somewhat complex to disintegrate from the customers' system will make them hesitant to unsubscribe. They will have more to lose than to gain by leaving you. Good stickiness therefore helps to minimize your turnover rate. Consider this in your strategy!
Once you know your ratios and set your fair price, you reach the snowball effect mentioned above. Indeed, unlike a service provider who must revive their clientele or find a new one every year, a SaaS company never starts from scratch. It only increases its revenue.
But be careful, I didn't say that it was increasing its profits.
Profitability still postponed
Why does the SaaS model not guarantee high profits? Indeed, to counter the effect of unsubscribes, it is necessary to constantly invest in customer development, the cost of which will be higher than the revenue generated by subscriptions during the first 12 to 36 months. The cycle will have to be repeated infinitely to increase the value of the company.
Once you adopt the SaaS model, you will need to constantly keep an eye on your ratios to ensure that they remain favorable and that the business is gaining value.
You can of course stop or slow down your customer development at any time, if your ambition is not to sell to the highest bidder, but rather to ensure long-term income. However, in the SaaS field, more up-to-date competing companies can always replace you if you stop investing.
For growth models, there is no shortage of buyers. Indeed, SaaS services are popular with large companies that do not necessarily have the agility to create them themselves, but are interested in integrating them "turnkey" into their broader offering to increase their value.
As I announced at the beginning of the article, the SaaS model will make your exit much more lucrative than with traditional service delivery or software sales.
Comparing the value of a SaaS company and a “traditional” company
If your "traditional" income is $ 1.2 million per year with $180,000 in profits, the usual calculation for buyers is to offer you between four and six times the EBITDA , or $720,000 to $ 1.08 million . When the time comes to sell your business, this is what will be left to finance your next project or your retirement.
The same company that was valued on its profits will be valued on its total revenue once it moves to the SaaS model. It will meet the same need in the market with the same type of service, but it will be worth much more .
For their part, SaaS companies have been selling for several years at a value between six and 12 times their annual recurring turnover. These are multiples that are frequently seen in Canada regardless of the sector of activity.
Continuing with our example, we can estimate that the company's recurring revenue would initially be lower. For this example, let's say that revenue would be between $250,000 and $300,000. The company could therefore have a theoretical resale value of $ 1.5 to $3.6 million!
The same company that was valued on its profits will be valued on its total revenue once it moves to the SaaS model. It will meet the same need in the market with the same type of service, but it will be worth much more.
Perpetual License Software Company SaaS software provider
Turnover $1.2M/year $250,000 to $300,000 ( $20,000 to $25,000 /month)
BAIIA $180,000 $0 or negative
Multiple on acquisition 4 to 6 times profit (EBITDA) 6 to 12 times recurring revenue
Purchase offer $720,000 to $1.08M $1.5M to $3.6M
Find the right partners
Have we convinced you? Before you move forward, remember the cash flow issues!
If you don't have the means (and the nerves) to finance your business outright for a year or two, including the development not only of your customer base, but also of your SaaS product (programming, team setup, etc.), you need to find the right partners.
At BDC, we have helped many companies make the leap to the SaaS model. We generally intervene once their digital platform is up and running and they are starting to develop their new customer base.
In addition to financing during the initial revenue trough, we are used to juggling ratios and conducting market research to define the right long-term positioning from the outset.
If your company is just starting out in the technology ecosystem, we can introduce you to specialists and other key players in the sector who can help you get off the ground.
The next sectors suitable for the SaaS model
You might be thinking, "My industry isn't ready for this." I'd say the best opportunities are in the industries that move the least.
In industries where the SaaS model is more prevalent, such as financial services, there is less room for new entrants than in a field like construction, insurance, or healthcare.
Wherever delivery models have not changed for decades, the next SaaS success stories will emerge.