5 reasons why SaaS companies are valued on multiples of revenue, not profit

Public and private software company valuation multiples have come down hard this year, but they are still valued on MULTIPLES OF REVENUE.

Here are 5 reasons why SaaS companies are still valued at 10 times revenue on average:

1) RECURRING REVENUE is worth a lot

Steady recurring revenue that goes on for years is worth a lot more than a single transaction that doesn’t repeat.

You’ll be paying for Zoom or AWS every year for a long time, but you probably won’t buy another dishwasher or fancy steak dinner from that company again.

Not only is the total lifetime value of a SaaS customer much higher, but it’s steady, predictable revenue. Revenue that doesn’t drop off quickly when there is a recession or a new competitor.

2) Software companies have HIGHER MARGINS

Each new SaaS customer costs only a small fraction of your hosting fee and any royalties, plus what’s needed to onboard and support them. So 70-90% of each new customer’s revenue is leftover (gross margin) to spend on sales, marketing, R&D, and other stuff, like bigger profits.

If you sell a dishwasher or a hamburger or some other product or service, there is a lot more material and labor cost with each new customer and not much left over for other expenses or profits.

3) Software companies can keep growing and GET VERY BIG

Service businesses are easier to get going without investment, but they are very difficult to keep growing forever. It’s almost impossible for a law firm or marketing agency to go from 10 employees to 100, then 1000, and keep growing.

Most software companies with 100 customers have the potential to get 1,000 customers or 10,000 or 1 million customers someday–without adding the same proportion of employees. Investors can see the possibility of you getting 10x or 100x bigger with big profits.

4) There are MANY ACTIVE INVESTORS AND BUYERS

For the reasons mentioned above, recurring revenue software businesses attract a lot of investors and buyers with deep pockets. Even now with “recession looming” and more realistic valuations, fortune-seekers still compete for software companies with high growth potential.

These investors in public and private software companies are valuing software companies on multiples of revenue because the potential for crazy future PROFITS is so much higher (or a high-value acquisition) compared to other investments. The payoffs can be really BIG, as we have all seen.

Buyers are acquiring small SaaS companies with $2M or $5M ARR for more than 10X multiples too.

5) SaaS companies can reach big GLOBAL MARKETS

Most small business and service companies are local or regional. Most software companies can sell nationally and internationally, from wherever they are. It’s not easy to sell your software in new global markets, but it’s possible.

And the global market for software is still growing fast as economies get bigger and technology adoption grows.

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