What Will SaaS Valuations Look Like Next Year?

August 31, 2016

On the last day of August, as we go into the final stretch of Q3 and 2016, SaaS valuations are evolving.  Benchmarking the financials and operating metrics that drive these valuations is what OPEXEngine, the member-based benchmarking community for SaaS companies, is all about.

Forward multiples have rebounded for companies maintaining strong revenue growth at respectable margins.  Back in February, public SaaS companies had fallen 57% from their highs. The enterprise value to forward revenue more than halved from 7.7x to 3.3x.

The Bessemer Venture Partners cloud index, which tracks more than 40 publicly traded cloud software companies, plunged 35 percent in the first six weeks of 2016.SaaS valuations correction is triggered a flurry of consolidation in software, with nearly $70B+ worth of exits year to date in 2016. Over the last six months, however, forward multiples have reverted to the mean, according to analysis published by Tomasz Tunguz, a venture capitalist at Redpoint in his blog.  In addition, Tunguz shows that SaaS valuations for companies maintaining good revenue growth with a respectable profit structure, have rebounded.  For SaaS companies in the top quartile, enterprise value to forward revenue reached a multiple of 7.6 in August.


PE’s Infatuation with SaaS

PE firms have jumped into the SaaS space with unbridled enthusiasm in the first half of 2016 as an undervalued sector showing stronger growth than pretty much any other sector with a market forecast of 20% for the near to mid-term.   The huge PE buy-outs like Marketo, Cvent, and Ping Identity by Vista Equity Partners and Qlik Technologies by Thoma Bravo for $3B get a lot of attention, but mask the fact that PE firms have been multiplying (something like 6,500 now worldwide) and moving downstream to buy hundreds of mid-market, mid-sized firms.Two dynamics that we think SaaS companies should be watching as they start 2017 planning are:

  • if PE firms have learned that SaaS is all about fast growth (as they say they have), will they be able to fund growth with greater efficiency than we’ve often seen in the past few years of the SaaS evolution, and
  • assuming that the goal of most of these buy-outs is to bring a more attractive looking company to the IPO altar, how will increasing numbers of data driven, efficient, growth companies affect the dynamics of valuations?

A Quickie or a Relationship of Mutual Respect and Growth?

It is safe to say that PE firms aren’t investing $70B in SaaS companies to supply more ping pong tables and daily catered lunches. At the same time, given the SaaS business model by investing in new customer acquisition and building long-term valuable customer relationships (and thereby achieving two to three digit growth rates), PE’s traditional slash and burn approach won’t improve enterprise value in a competition to hold customer loyalty year over year.The key for everyone building and growing SaaS companies going forward will be to see how increasing numbers of PE-run companies affect the balance in operational metrics for costs & expenses versus growth in 2017.  Benchmarking these ratios and how they are changing is what OPEXEngine does.One thing is for sure – companies offering daily catered lunches to all employees will have to document increasing employee productivity to justify the expense.