We see a synergy in acquiring the SaaS businesses that support ecommerce too. Acquiring a SaaS business used by hundreds or thousands of ecommerce entrepreneurs helps identify more ecommerce acquisition targets. SaaS businesses also have strong profitability and leverage. The first 44 software as a service (SaaS) businesses in the public markets have total enterprise value (TEV) to forward revenue multiples at a median point of 5.7x. In 2018 and the first half of 2019 the multiple moved between 7.1x and 9.6x.[i] SaaS businesses have several attributes. First, like general software businesses they are able to earn higher margins. One analyst observed,
We like SaaS companies’ high gross margins. Gross margins typically range from 60% to more than 80% with the primary cost of goods sold being network and delivery costs, as well as services personnel (e.g., maintenance, training, implementation, etc.). As the customer base matures and the company reaches scale, most SaaS companies should achieve gross margins in the 75%–80% range.[ii]
Second, because SaaS businesses make their services available online, they tend to have lower distribution costs because they are not sending disks to customers or needing to get their software to hardware manufacturers for installation. Because their software engineers have unique skills for creating their intellectual property, SaaS businesses also have the protections that come with a somewhat higher barrier of entry for competitors. SaaS businesses also benefit from subscription-based pricing and the recurring revenue that comes with customers maintaining access to the software.
With SaaS businesses we find the same debt underwriting difficulty. The companies are renting their information technology. They have already built and deployed their software and need only make incremental improvements. Their distribution is paid for by others in the form of the Internet and end-user devices. This simplifies adoption. We have already experienced finding great SaaS businesses, concluding due diligence that reinforced our reason for investment, but have been unable to find banks that understand SaaS businesses well enough to finance the acquisition. More troublesome are the bankers encouraging us to artificially pay more or restructure the deal to fit the firm’s investment committee norms.
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Over 2019 we saw opportunities to invest in 51 companies. Collectively they represented more than $55M in annual revenue, and delivered $22M in net income. If we had purchased every company at the listed asking price, we would have needed a budget of $111M. Table 7 below provides the descriptive statistics for the 51 companies. Note that the statistics are independent from one another.
Table 7. Descriptive Statistics on 51 SaaS Businesses for Sale in 2019.
|Revenue||Net Income||Sales Price||Multiple||Net Margin|
When we evaluate SaaS businesses we look at five critical areas of their business model.[iii] First, we want to understand how big the total addressable market is they are in. Second, we look at how they acquire customers. This includes looking at whether the cost of acquiring new customers is going down over time. Third, we look at retention of customers. This is accomplished by evaluating the “churn” ratio of the business, which reflects how many subscribers are leaving their platform versus how many new are joining. Next, we look at the economics of the business including the life time value of the customer and the overall margins the business is generating. Finally, we also look operationally at the opportunities to consolidate the business into a cloud services provider, enhance the security of the platform, and improve its resilience to emergencies or disruptions.
As analysts who track SaaS businesses note, they are rarely a home run on all key performance indicators. When they are, their valuations tend to reflect it with a premium. The key is to find businesses still in high-growth phase with 50%+ annual growth, sales revenue less than $100M, and stable cost structures that enable reasonable estimation of the business’ future break-even point and profits.
The SaaS segment is still in its early growth stage. It is worth $60bn in 2019 and is growing at 9%.[iv] However, it is merely a segment of the $507bn software market growing at almost 6%.[v] This makes the segment attractive as an alternative asset.
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