How To Value a SaaS Startup

Every startup valuation presents a unique challenge. It’s not just about throwing numbers into a spreadsheet, or finding a list of similar companies and hoping for the best; it’s about crafting a narrative that resonates with investors and accurately reflects the future potential of your company. If you’re serious about raising capital, you need to get this right.

In this article, and the associated video, we’ll walk through how to approach the valuation process using the example of Energy Pro, a fictional UK-based SaaS startup that helps businesses manage their energy consumption.

The Importance of Financial Projections in Fundraising Strategy and Valuation

Financial projections serve as the bedrock of your fundraising strategy. These projections are not just numbers on a spreadsheet; they are a narrative—a story that outlines the future potential of your company. For a SaaS startup like Energy Pro, these projections encapsulate the assumptions around customer acquisition, conversion rates, pricing, and the long-term growth strategy.

Even if your company is in the very early stages, having projections — no matter how rough — can significantly impact your fundraising discussions. Investors are not just looking for the current state of your business; they want to understand where it’s headed. Projections give them a window into that future, with greater clarity on the associated growth of revenue (and costs), which will ultimately inform valuation.

Future Revenue: Crafting the Narrative

Financial projections are the backbone of any startup valuation. They provide a narrative of where the company is headed and form the basis for future growth assumptions. For Energy Pro, we started by defining revenue streams, customer acquisition costs, and growth rates.

1. Revenue Assumptions: Energy Pro’s revenue comes from two subscription tiers: a basic monitoring service and a premium service with automated energy management. By estimating the number of customers and average revenue per user (ARPU), we projected the company’s future revenue.
2. Cost Assumptions: We factored in marketing expenses, operational costs, and salaries. Given the SaaS nature of the business, scalability is high, meaning costs won’t scale directly with revenue. This allows for a potentially high margin as the company grows.
3. Growth Assumptions: We assumed an ambitious growth trajectory, targeting market leadership in the UK, with eventual expansion into Europe. This aggressive growth plan is crucial for driving a higher valuation but requires substantial investment in both marketing and product development.

Cost Projections: A Comprehensive View

Costs are where many startups stumble. You might have a great idea and a solid plan to bring in revenue, but if you don’t keep your costs in check, you’re going to burn through your cash before you even get out of the gate.

1. Salaries: This is going to be your biggest expense, especially if you’re planning to grow quickly. Don’t just budget for what you’re paying people now—think about what it’s going to cost when you need to scale up.
2. Marketing: You can’t grow if no one knows about you. But marketing isn’t just about throwing money at ads and hoping something sticks. You need to budget for it realistically, based on what’s actually going to drive growth.
3. Technology: Running a SaaS platform isn’t cheap. There are ongoing costs for servers, software, and development that don’t go away just because you’ve launched. Plan for these, or they’ll eat you alive.
4. Finance and Overheads: Don’t forget the boring stuff—legal fees, accounting, office space. These might seem like small line items, but they add up quickly.

While investors may not care about ‘profit’ initially, they do care about the quality of your revenue and your financial health as a business. If you’re having to spend $20 in marketing or sales to acquire a customer, to make $10 back in revenue, you’re going to struggle to make a compelling case for scaling that business. This is why it’s crucial to think through your costs, and demonstrate a solid breakdown of current number and future projected numbers.

Refining the Valuation: Adjusting Assumptions and Projections

With the financial projections in place, the next step was to input these into the Equidam platform to generate a valuation. The platform considers both qualitative and quantitative factors to provide a comprehensive assessment.

1. Qualitative Factors: We assessed the founders’ experience, market size, competitive landscape, and the scalability of the business model. Energy Pro scored well on scalability and market opportunity but faced challenges due to the low barriers to entry and a crowded competitive landscape.
2. Quantitative Factors: The financial projections were uploaded, giving us a clear view of future cash flows, profitability, and required funding. The projections showed a company with strong growth potential but one that needed significant capital to achieve its goals.
3. Initial Valuation: The preliminary valuation came out to around £3.4 million. However, this figure felt conservative given the company’s potential, suggesting that adjustments might be necessary to align with investor expectations.

Valuation is rarely a one-and-done process. It involves iterations based on feedback and further analysis. In Energy Pro’s case, we considered two key strategies:

1. Scaling Down the Funding: We explored a scenario where Energy Pro raised only £1 million instead of £2 million. This leaner approach would still enable growth but with a focus on maintaining higher profitability. The adjusted projections led to a valuation closer to £9 million, reflecting a more balanced risk-reward profile for investors.
2. Increasing Growth Ambition: Alternatively, we could boost the projections to include more aggressive expansion into Europe. This would likely require maintaining the £2 million raise but would justify a higher valuation by promising substantial returns in the future.

Setting the Context: The Importance of Benchmarking

When valuing a startup, it’s crucial to understand where your company stands within its industry and market. This involves benchmarking against similar companies to see what they are raising, at what stage, and at what valuations. This context is vital because it helps ensure that your expectations align with current market realities.

For example, let’s consider our example company, which provides energy monitoring and analytics services. The company is seeking to raise £1 million to expand its market presence. Before setting a valuation, it’s important to benchmark against other startups in the same region and industry.

Key Steps in Benchmarking:

• Identify Similar Companies: Focus on companies that operate in the same industry, have similar business models, and are at a comparable stage of growth.
• Analyze Recent Funding Rounds: Look at data from sources like PitchBook or Crunchbase to see how much similar companies have raised and at what valuations.
• Adjust for Unique Factors: Consider any unique aspects of your business, such as a lightweight operating model or a focus on R&D rather than operations, which might justify a deviation from the benchmark.

Understanding and Applying Multiples

Multiples are a key component in the valuation process, but their application, especially for early-stage startups, can be tricky. They are often used to compare a company’s value to its financial metrics, such as revenue or EBITDA, but in the context of a startup, their relevance can vary.

Multiples in Early-Stage Valuations:

• Output, Not Input: For startups, it’s important to remember that multiples on today’s revenue or EBITDA are an outcome of the valuation process, not a starting point. As Andreessen Horowitz suggests, investors should see this multiple as a result of the company’s potential, rather than the foundation of their valuation.
• How Equidam uses Multiples: We determine multiples based on public market comparables, and apply them to the revenue or EBITDA multiple to the furthest year out in your projections, which allows you to reflect future performance and growth potential.
• Industry-Specific Multiples: Start with industry-standard multiples but adjust based on the unique attributes of your company. For instance, in the case of Energy Pro, the industry multiple might be around 14x EBITDA, which aligns with similar public companies like Schneider Electric or Johnson Controls.
• Caution with Implied Multiples: Be careful with implied multiples, which reflect the current valuation relative to today’s revenue or EBITDA. For early stage startups, these can often seem disproportionately high, reflecting the high growth potential rather than stable, ongoing operations. The multiple on current revenue or EBITDA will contract as the company grows and revenue increases.

Final Thoughts on SaaS Valuation

Valuing a SaaS startup like Energy Pro involves a delicate balance of ambition and realism. By thoroughly analyzing financial projections and aligning them with market opportunities and operational realities, you can arrive at a valuation that reflects the true potential of your business.

Remember, valuation is as much an art as it is a science. It requires ongoing dialogue with investors, iterations based on feedback, and a clear understanding of your startup’s growth narrative. With tools like Equidam, you can streamline this process, making it more transparent and accessible.

Stay tuned for our next article, where we’ll dive deeper into refining valuations based on investor feedback and exploring advanced settings within the Equidam platform.