EBITDA vs. ARR multiples for SaaS
What kind of multiples is used by buyout and growth equity investors (e.g., Hg Capital, Summit Partners, TA Associates) to value SaaS companies? Do they only rely on EBITDA multiples just like for "traditional business models" or use ARR/revenue multiples as well?
Looking at the cash flow profile of SaaS companies, some might be EBITDA negative, but operating cash flow positive thanks to up-front collections on annual contracts. Besides, looking at the public market, looks like there's a strong correlation between the ARR and the market cap; and some EBITDA multiples just sound outlandish (cf. Workday being valued > 1000x EBITDA).
Any insights from practitioners or SaaS specialists would be more than welcome. Thanks!
It’s kind of an either or thing; cash burning companies will use an ARR multiple, cash flow positive will use a cash adjusted EBITDA. There’s kind of a no man’s land where companies go from unprofitable to profitable (or break even to profitable) and a lot of firms that specialize there; buy on arr sell off ebitda
To your point on might be operating cash flow positive while ebitda negative, sure that’s true and that’s a classic cash ebitda adjustment but if you’re at the break even ish point anyway it’s like you’ll be valued on arr
It's obviously case-by-case, but what I see (as a growth equity investor) is that software businesses with 25%+ EBITDA margins will trade on EBITDA multiples, and below that the banker will usually guide buyers to a revenue or ARR multiple. That being said, even for highly profitable businesses the revenue/ARR multiple is relevant and often quoted.
When looking at a deal we'll look at both, assuming the company generates meaningful EBITDA.
Since they are retarded they value on arr.
I'm not expert in SaaS but a few thoughts I would like to contribute:
1) typical SaaS model is long-term 75%+ gross margins and 20%+ operating margins. at an early / growth stage you'll likely be spending 100%+ of revenue on the SG&A / R&D growth portion and then tease out the operating leverage to get to positive EBITDA. in this early stage you'll see companies forcibly valued off of TEV / revenue as the EBITDA is negative. in today's environment, it's quite normal to see > 10x TEV / revenue. this is the most common used valuation measure... take a look at all the $3-15bn SaaS / platform tech companies out there this year.
2) the issue is that revenue is often a trailing 12 months indicator and so some will adjust to use ARR or the run-rate form of the past quarter to be more current. so you might see TEV / ARR multiples. even then, ARR is still stale compared to a leading indicator like billings, bookings or RPOs. so TEV/bookings is another possibility.
3) some companies it's more appropriate in terms of benchmarking to value off of operational KPIs. so you might see TEV/MAU or TEV/clicks or TEV / GMV for platforms such as ABNB / Afterpay / etc.
4) as you get to later stage you will see FCF (CFO less capex) break even and once that becomes stabilized at say 25%+ revenue margin, you'll see a P / FCF or FCF yield on price being used (barely any debt is used in public SaaS so TEV effectively = market cap with net cash position). or you'll see the typical TEV/EBITDA multiple. then it becomes another vanilla / conventional multiple valuation exercise.
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