New research from Aaron Wallis Sales Recruitment* suggests that despite current macro-economic challenges, the UK SaaS sector is forecasted to have revenue growth of +5.3% in 2023 contributing to a total predicted market size of £33.2bn.

As an active M&A corporate finance advisor across the UK, we’ve worked with the founders of SaaS (Software-as-a-Service) businesses to help them exit their shareholdings and sell to larger players.

If you own one of the estimated 2,100 SaaS businesses in the country, you may currently be considering an exit. Our view, however, is that now would be the wrong time to choose to sell your SaaS business given the state of the market, with both buyer appetite and valuations significantly down compared to a year ago.

An integral reason for holding fire on a SaaS business exit is that tech stocks have fallen, with the NASDAQ 100 Technology Sector Index down as much as 25% on a peak that was reached towards the end of 2021. This means that larger companies are now more selective about the SaaS business acquisitions they will undertake, and it’s of little surprise that the valuations now being applied to ongoing acquisitions have dropped significantly since 2021.

Of course, deals will continue to happen, but SaaS buyers will also be far more focused on profitability – something that will be difficult for many companies to demonstrate in the current economic climate. Nevertheless, if you are considering exiting your SaaS business - at whatever point - it is still very important that you liaise with a corporate finance expert who will help ensure you get the best possible deal, or help you prepare your company for more lucrative times.

With this in mind, 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.

If you'd like to discuss how we can help you fund, sell or buy a business, please contact me or book an informal chat via our website

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

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