How to really value a SaaS business
Being a software-as-a-service (SaaS) company, we live and breathe the internet and cloud technology. It’s where the world is, you’ll be hard press to go about your everyday life without using the internet in some form, whether it’s for your day-to-day job, for entertainment purposes, or even just to stay connected with friends and colleagues. It seems, today, that everyone and everything is moving online.
Well, almost everyone. We’re still waiting for some very important industries to make the move to online. Research from Tata Consultancy Services on cloud adoption across global industries suggests industries with the fewest number of cloud apps were healthcare services, chemicals, energy and utilities, metals and mining, and media/entertainment/sports.
One of the biggest drivers for us is continued growth, we refuse to stand still and we’re not afraid to make large up-front investments to drive those ambitions. As CFO, I’m the one that must make sure that we have the means to continue to put our profits straight back into development, knowing full well that this will not only help to retain existing customers, but also generate new customers and future larger profits.
These investments are all expensed in current earnings before interest, taxes, depreciation, and amortisation (EBITDA) and that’s where the challenge really begins. Financial institutions measure the value of a business on a multiple of your EBITDA. Forgetting the numbers that actually matter; a multiple of annual recurring revenue (ARR) or guaranteed contracted income for the next five years, many can’t get past that EBITDA figure.
In essence, for a cloud business to look attractive to financial institutions and investors, re-investing capital back into the business to improve and develop new products may not be the best bet.
Of course, you could quite easily sit back and reap the benefits of ARR and post a huge EBITDA figure at the year-end, which as CFO, you would, no doubt, be absolutely delighted with. But who else would be? Would your customers be happy that you’d failed to develop or further improve their experience? Would you be happy to stop innovating?
I’ve been with Selenity (formerly Software Europe) for three and a half years now and in that time I’ve encountered some interesting challenges for both the business and myself. It’s not the usual problems you may come across such as poor cash flow, lack of new sales or loss of existing customers, far from it. The challenge is much different and more difficult to understand and to put it bluntly; we’re waiting for the rest of the world to catch up.
It’s a challenge common to SaaS companies; deferred revenue and how it’s perceived in certain industries, particularly the effect it can have on the company credit rating. Like most SaaS companies we bill customers in advance for our service, which leads to deferred revenue on our balance sheet.
This is looked upon as negative working capital and represents a debt to the business. The reality is that this deferred revenue is not like other liabilities, the deferred revenue liability reduces over time through the delivery of the service and there isn’t a cash drain on the company that the figure on the balance sheet suggests.
I think, in part, there’s a lack of understanding of the SaaS model. We’re constantly innovating and looking to improve our customer’s experiences and it’s an approach that is paying dividends, so being measured purely against a multiple of the EBITDA can miss the innovation that takes place.
Of course, these are the experiences I’ve had a Selenity, but these challenges aren’t individual to either me or the company. Other, similar cloud and SaaS businesses are facing the same issues.
Whether your ambition is to get acquired, or to develop and grow your business to become a behemoth, educating the market on how SaaS models work and moving beyond EBITDA measurement will ultimately help your company realise its goals. Reaping the benefits of the SaaS and cloud business models only comes through understanding them.