Regardless of market conditions, here are some key things that buyers of a SaaS business will always be looking for:

1) For a loss-maker, demonstrating a route to profit will be key

In the earlier stages of their life SaaS businesses need to invest in developing their software and the systems and processes to support growth. Many up-and-coming SaaS businesses are therefore making little profit or are reporting a loss just as they become of interest to larger businesses.

Strategic acquirers in the SaaS sales space understand that they will be able to accelerate growth several times over and with growth comes profit. We’ve found that a good SaaS company can go from making little or no profit to making a very strong profit margin in a short period of time post-acquisition. Therefore, while a strong profit margin is not necessarily required to achieve a good exit, being able to demonstrate a near term route to profitability is now essential. Of course, it’s important to remember that pressures on the acquiror themselves from their own funders means that their scope to give you the benefit of the doubt has been curtailed significantly.

2) The Rule of 40 is Now 30

Revenue growth of a SaaS company can still be traded for profit margin, but Ebitda (before any capitalisation of development costs) now needs to be positive. Many players in the sector used to quote the ‘Rule of 40’ to assess if a business is hitting the right metrics. In simple terms, this is the annual revenue growth rate plus or minus the Ebitda margin of the business after development costs (a proxy for cash conversion), which should be at least 40.

For example, a SaaS business making a 10% Ebitda loss but achieving ARR (‘Annualised Recurring Revenue’ or, in other words, your last month's recurring revenue multiplied by 12) growth of 50% would meet the rule. However, in the current market, a SaaS business making an Ebitda loss will be an issue for a buyer even if revenue growth is strong. The example given of a loss-making SaaS business growing at 50% would no longer be of interest. A SaaS business that is breakeven with growing revenue at 30% would be, suggesting that in the current market the ‘Rule of 40’ has now become the ‘Rule of 30’.

3) Scale

The other key factor is scale and our rule of thumb if you are a SaaS company is to be at or close to £2m of ARR. As your ARR increases to £3m, £4m and then £5m or more, and so long as the Rule of 30 continues to apply, each ARR milestone achieved will provide greater comfort to buyers which will in turn be reflected in increased appetite and pricing. Nervous buyers are less willing to ‘hope’ for growth post-acquisition and now need to see something from a SaaS company that moves the needle on day one.

If your SaaS business is already demonstrating the qualities above, it is likely that larger players in your sector will already be taking an interest in you. As mentioned however, in the current climate it is unlikely that you will achieve the best valuation for your SaaS business and to protect value it is vital that you seek the advice of an experienced corporate finance advisor.

Myles Hamilton is a Director – M&A at Shaw & Co.

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* AaronWallis Sales Recruitment – https://www.businessleader.co.uk/saas-as-a-model-the-state-saas-sector-in-2023/