Selling a SaaS Business? The Metrics Buyers Care About Most

Speaker A: Foreign. Hi, I'm Sauravaziri. I'm an I advisor in the state of California and today I have the pleasure of having somebody who is specialized in selling SaaS companies. David, welcome to Business beyond you.

Speaker B: Thank you Sarah. Excited to have this conversation.

Speaker A: Awesome. So for the people who don't know what is a SaaS company, can you tell us a little bit about what exactly is considered a SaaS business?

Speaker B: Uh, so a SaaS business is a product based company. They produce a product, um, and they um, uh it solves a recurring usually business problem. The key with the SaaS business is the value is not in the source code, it's software, it's source code. Um, the key is that um, the customers keep using it and it's that recurring revenue that comes in every month. And because the revenue is so predictable, um, the businesses can grow very large.

Speaker A: M so is that the reason that these kind of businesses are really attractive? Uh, acquisition target is for a lot of buyers.

Speaker B: Uh, it is, you know, in the olden days like before 2020, um, software was sold um, under a perpetual license and you would buy a license then you'd be able to use it forever but there'd be no more cash coming into the business. Um, the advantage of a SaaS is because the customers um, pay every month. Um, there's constantly incoming revenue and that's what makes it so attractive and it's such a powerful business model.

Speaker A: So as somebody who is dealing with selling this kind of businesses day to day, tell us what is different when you want to sell these kind of business versus like a manufacturing or service based company or other type of business.

Speaker B: Um, I would say that um, you know, there is some technical details that need to be resolved and um, the buyers are looking for, I would call it explainability and simplicity. Um, they don't like obscure, you know, software development languages. But as long as it's one of the standard ones that's, you know, with a widespread group of uh, engineers available, that's fine. Um, the real analysis is a, ah, sales and marketing. So can you um, cost effectively attract new customers and, and do you keep your existing customers? Because again it's a recurring payment. So um, the level of churn and the cost of acquisition are really the metrics and um, uh there is extensive um, investigation and diligence on that aspect of the business.

Speaker A: Um, I think that I have uh, referred to you, some people before that. They said uh, yeah, I have this kind of software and it's amazing. And you constantly say if it's just the software and doesn't have any customers, doesn't have value. Correct.

Speaker B: Yeah. I mean my saying is code is not the company, the customers are the company. So I'm always looking for customers, um, a growing customer, uh, list and um, uh, not a lot of concentration in one big account. Um, and then it's sellable. The business doesn't even have to be profitable. You just need customers. Um, but source code without customers is um, you know, like a restaurant with no eaters. Right. You can make great food, but if nobody eats it, who cares?

Speaker A: But that was a very uh, interesting point. You said that profit is not important in this type of business. It's more customers and that growth rate.

Speaker B: Correct? Right. Because one of the reasons that these software uh, companies sell for such high value is the growth potential is so high. Right. There's, it doesn't cost much more to deliver software services to one more customer. Uh, the marginal cost is very low, unlike a manufacturing business. So the businesses can become incredibly profitable at scale. And what the buyers are looking for is, you know, how large can this business grow? And as long as it's predictable, meaning you can add customers at a, ah, cost lower than you um, lose them. Um, uh, they'll pay for an unprofitable business if the growth rate is good.

Speaker A: But if I have the best code in the world, but I haven't proved that I can get customers, I don't have that.

Speaker B: You know, there might be somebody out there that can sell your source code, um, but it's not me. I've tried and it's just, it's not like the offers don't come in that are good. I can't find a single offer. Um, because in general these opportunities are so large that um, anybody that would want to buy your source code could probably create their own for less and then they would get exactly what they want rather than trying to figure out what you've created and then modifying it to fit their ideas. It's usually simpler and less expensive just to start over.

Speaker A: And it was always like that. And I think right now by AI coming to the sourcing and coding uh, era, then everything even is worse.

Speaker B: Yeah, I've written a lot about AI because there's this AI apocalypse that's in the popular media right now. And uh, my take is a little different. I do think that AI is going to wipe out a lot of um, like horizontal software products. So um, like reporting tools and dashboards, all of that. You can recreate yourself fairly easily with AI. Um, you know, there's no more barrier, uh, based on the cost of creating code. But where the barrier exists is do you understand the customer? And you get into these vertical markets, like I just did a deal with agriculture, you know, they knew all the nuances of picking fruits and vegetables. And how do you manage these employees and how do you report productivity? And it's not about the code, it's about the business knowledge and the connection and trust from the customers.

Speaker A: M so based on what you see in the market, who are the typical buyers of these kind of businesses?

Speaker B: Um, so unlike general business brokering with Main street, um, the issue you run into with a SaaS business is the valuation multiples are fairly high. So you quickly run through the SBA loan limit. Um, and that means that you're going to have institutional buyers, private equity, corporate strategics, sometimes a search funder. Um, but it, you know, you, you really need institutional capital. And I find that when uh, I work with my clients, kind of translating between a bootstrap entrepreneur and an um, you know, a financial analyst at a private equity is, they're speaking different languages. And uh, that's where I feel that I can add a lot of value.

Speaker A: So in this, usually in traditional type of businesses the valuation is based on ebitda. Ah, based on what you say, even if the business is not profitable, it could have value. So how do you value this type of businesses?

Speaker B: So you, you need to think about where the business is and its evolution. Um, I worked on a deal that was a very mature software company, had been around for 20 some odd years. They did uh, an accounting function. So very boring back office, you know, not exciting at all. Not Internet. Um, they had you know, thousands of customers. And um, that of course would be valued based on ebitda. Right? Because it's a cash flowing business. There's no growth there, it's just maintaining these accounts and keeping everybody happy. Um, a smaller business that's new in solving a new problem or a new approach to an existing problem that's growing quickly, meaning more than 20% a year. Um, that could be valued based on revenue.

Speaker A: Oh, okay. So you look at the revenue and of course the growth rate, right?

Speaker B: And then you know, some at the um, I wouldn't call it low end because these can be very large businesses. But some of the tightest multiples would be um, really what they call an acqui hire. So you know, you've built a software product, you've gotten a few customers, but there's major problems, right? It's just, it's not Going to grow something. Some strategic decisions were made incorrectly or the market changed, but you have a very strong team. Um, there would be people that would want to buy your entire staff, and they would want to buy it as a team because these people already know how to work together. And that would be called an Aqua Hire. Um, those multiples are based upon more like a recruiter. Right. You would get a, a percentage of the salary that would be paid out to that team in the first year as compensation for putting the team together.

Speaker A: Oh, okay. So m. What metrics really matter the most in these type of businesses?

Speaker B: Um, so if it's a, um, a recurring revenue business like a SAS company, you're really looking at Churn. And they're going to calculate that two ways. One is, you know, just customer names that come and go and you're looking at a percentage. The other is revenue. So how much of the subscription, uh, revenue that you got paid last year will you receive this year? Uh, they'll look at the, uh, net recurring revenue, which is, um, how much you're able to grow your existing accounts. So over 100%. That means your existing customers buy more licenses or more, um, functionality. Um, and then the other big thing, um, is Churn or Churn. Yes, I already said that. I got lost. Uh, turn. Oh yeah. And then the other revenue is the cost of acquisition. So you know, if you're going to, if the average customer lasts three years and you're going to make $300, can you sign that customer up? Do you have to spend less than $300 in marketing and sales commissions to get that customer to sign the agreement? So customer acquisition cost and Churn are probably the two largest with a net revenue retention is number three. Which means not only are you producing more revenue, but by getting customers to spend more money, you're showing that the product is valuable and people like it.

Speaker A: Before I forget, at how many customers or what revenue is the level that you consider business sellable.

Speaker B: Um, so a small business that's generating a half a million dollars a year will attract an owner operator. So let's think of like an ex corporate software developer that's, you know, just wants to change and doesn't want to do the corporate thing anymore. The multiple will be low because it's a person spending their own capital to acquire the business. Um, generally if you want institutional capital, you're looking at 2 to 3 million dollars in recurring revenue as the, the bottom. And um, generally I'll work on deals up to 10, $15 million in recurring revenue. And after that um, they really get too complicated for a business broker to handle and they need to go to a regional investment bank. Um, but between that kind of, you know, 2 to 15 million, um, I'm generally comfortable working with clients and getting deals done.

Speaker A: Nice. So what kind of, what, what is the worst mistake you have seen that a SaaS business owner the market to sell their business?

Speaker B: Um, well the first one we touched on early thinking that their code has value and the code doesn't have value, it's the customers. Um, but I would say um, creating systems which is a, you know, usually a tough transition for a business owner, um, because they want to do everything themselves because they want it done their way, you know, the right way. Um, but that's really um, that's where the value of the business will take a jump. If you can bring on a team and create systems and processes in place where you know, you're able to manage the business by looking at an email or a spreadsheet with statistics as opposed to, you know, constant telephone calls throughout the day, that's when you're going to jump. And the multiples, um, you know, prove that on deals.

Speaker A: Okay. And how long before the sale do you suggest them to start working on this exit plan?

Speaker B: I think if you're thinking about exiting a software company, you know, two to three years to build a team, um, is probably what it takes is it's, you know, it's hard to hire good people and if you've never done it before, your ability to train people is going to be slow. You know, the more you do it. If you are already hired two salespeople and you want to bring on a third, you've probably learned how to hire and train a salesperson, teach them about your product, customers, messaging, uh, but the first time is very time consuming so.

Speaker A: And ah, like similar other businesses you suggest them to document all of the processes and everything like that also matters in this type of business as well.

Speaker B: Correct. And there are people out there that can help. There's a lot of consultants in the space and you know I've spoken to many there, some of them are very good and um, uh, you know while it's more expensive to hire somebody to help you, the advantage is, is it goes very fast.

Speaker A: M And um, how much is important, how heavy the owner is involved in different part of the business.

Speaker B: Um, the owner shouldn't be involved at all.

Speaker A: That's the best scenario.

Speaker B: Yeah, yeah. I mean, you know, if you got hit by a bus, what happens to the business? Um, Generally, you know, ideally there should be a weekly or a monthly status meeting where the management team meets and, you know, big strategic decisions are decided, and that's where the owner should spend their time. Meeting, um, with key customers is also important and completely normal. Um, being involved in the details of the day to day, you know, being on top of engineering and product testing and then having to talk to new customers and, um, that's not attractive to buyers.

Speaker A: Right.

Speaker B: If you're doing a lot of, uh, owners think, oh, you know, I work 60 or 80 hours a week, look how hard a worker I am. I want to brag about that to a buyer. And what the buyer here is, oh, I can't just replace you, I got to replace you and hire somebody else. Let's lower the EBITDA by a second salary. So really kind of working your. Eliminating your job through documentation and automation

Speaker A: processes and hiring good people. Okay, what have you seen during due diligence that made the, uh, buyers nervous?

Speaker B: Um, sellers that claim to do everything and involved in all the detail, you know, the. I, I think most sellers would say, like, oh, you know, they'd be afraid to say, oh, I don't know that customer really well, Let me get on my salesperson to talk to you about that relationship. They think that negatively reflects upon themselves, but I think that's actually good. And the, um, the buyer says, oh, there's a team in place and they're knowledgeable about all the customers and there's processes and um, uh, yeah, I think having a good team.

Speaker A: M. And how do the buyers evaluate the strength of this team that the owner has? Have you ever had any situation that they come in and say that, okay, so this team doesn't have that much value or.

Speaker B: Yeah, yeah, I mean that's, you know, the, the fear of selling to a private equity group is that they're going to buy my company and, um, fire all my people, people that were loyal to me for 10 or 20 years.

Speaker A: And um, but how the private equity evaluates that this team is good enough.

Speaker B: Or they'll talk to them. Right? They'll have a marketing person talk to the sales team. And if the person can describe the product and knows the particulars of customers, um, then they're valuable. If you have an engineer, a technical person will interview an engineer, and if the engineer understands what's being done, um, rather than just coding what they're told, but they have some idea into the product design and the functionality and the customer use case, then all of a sudden they go from an expense to being a very valuable asset. And usually the right buyer values your team. Right? They want your customers, they want your revenue, they want your cash flow or projected cash flow, and they want your team.

Speaker A: So today in the market, there are a lot of businesses that are trying to use AI more and more, uh, based on what you see, how does change the valuation of the business? Does using AI add value or what do you see in the market?

Speaker B: Yeah. So back to what we talked about earlier. Uh, my take on AI is that it's going to wipe out, um, very thin functionality, simple things like reporting tools and utilities that people have used to kind of run their infrastructure because it's just easy to code it. Um, on, uh, the more positive side, I think AI can drastically reduce the cost of creating features. So if you're in a market and you have a large installed base, um, you know, you can potentially branch out into other related markets because you can very quickly add new features and functionality by using AI to improve the productivity of your engineering team. And that's where I see it. I think it's, you know, when there wasn't much there, the AI has reduced the value because the cost of creating it is so much lower. When there's a lot of market knowledge and customer trust, I think AI will accelerate the growth because they can, um, serve more customer needs, uh, less expensively and faster.

Speaker A: David, thank you so much for joining us in this episode of Business beyond you and sharing your practical knowledge. Uh, tell our audience, first of all, what kind of businesses exactly do you sell and how they can reach out to you if they want to. They have a business and they need your help to sell it.

Speaker B: Sure. So for, um, software, client server or SaaS companies, I'm looking at 2 to 15 million in recurring revenue. Um, for, uh, other like IT services, MSPS, um, I'm looking for at least 500,000 in EBITDA. Um, I'm happy to talk to anybody and see what they're doing and give, uh, you my thoughts. I'm, you know, not a consultant, but I'll tell you if I think it's marketable or if it's marketable. But I'm not the guy, you know, I'll tell you that. Um, the best way to reach me is through email. It's david.jacobsbbcorp.com or my phone number, 415-297-8562.

Speaker A: Thank you. And we will add all this information under this video. But again, thank you so much for your time and joining us in this episode.

Speaker B: Okay, thank you. Sarah. It was fun.

Speaker A: Have a great day.

Speaker B: You too.