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Valuation Model: Backsolving valuations for SaaS Companies at Series A (and beyond)

by Martin Janicki

I never considered myself much of a writer, and I am not sure anybody else ever considered myself to be much of a writer either. This is my virgin attempt at blogging, so please be gentle down there in my little comments section.

With Figma being acquired by Adobe at a reported >50x ARR multiple and public comps trading closer to 5.0x ARR it is hard to price anything right now, even more so at the early-stage. I took the opportunity to cobble together some generally accepted B2B SaaS “rules of thumb” into a small valuation framework, as over the past couple of weeks I’ve had multiple conversations with founders (and VCs) who are still finding their footing in the new (old?) status quo.

State of the Union

Public valuation multiples for SaaS companies have come down from elevated 2020 & 2021 levels and are currently closer to historical averages.

The chart above shows the median forward (or “NTM”: next twelve months) ARR multiple for companies in the BVP Cloud Index. NTM multiples are based on next year’s projected ARR and used to account for the underlying company’s expected growth rate.

This multiple has been compressed by roughly 70% (!) in 2022 YTD.

At the same time, median European software VC pre-money valuations continued to climb in the first half of this year. “Median” is the operative word here, as early-stage VC in particular is a game of outliers where the “hottest” companies command a significant valuation premium. Unfortunately, I do not have access to PitchBook’s underlying raw data for that chart; I imagine that it might be somewhat skewed by things such as the re-labeling of rounds — nonetheless, I think it is safe to say that we were in a situation where the rising tide lifted all boats.

“Only when the tide goes out do you discover who’s been swimming naked” says Warren Buffett. With plenty of VCs wondering to which extent they are being left exposed, the deal pace in 2022 YTD has been slower and summer vacations a lot longer.

Against this mental backdrop, I have heard all sorts of valuation benchmarks, many of which appeared to contradict generally accepted rules of thumb for early-stage SaaS, so I decided to do (and now share) some maths.

Valuation Model

I have built a small valuation model, you can find a download link at the bottom of this post.

It intends to help estimate whether the financing round in question (i.e. Series A) sets the company up such that it would be in good shape to raise a subsequent up-round (i.e. Series B), with some margin of safety. This template can also be used for later financing rounds; inputs need to be adjusted accordingly.

Please note that this model is always based on financing 24 months of runway. In practice, you will want to fundraise again earlier or increase the size of the current round.

The pre-populated inputs are based on what feels like general rules of thumb for Series A B2B SaaS (to me). Call it a plain vanilla scenario for a solid company, if you will, with a slight cautious tilt given the current environment.

Please check out Christoph Janz’ SaaS Funding Napkin to get some more benchmarks for those inputs (also at later stages).

Inputs

All inputs in the model are written in blue font.

For a better understanding — this is what the individual key values mean.

Starting ARR: Current ARR of the company, typically calculated as run rate, i.e. current MRR x 12.

Growth Years 1–3: Assumed growth rate for the company after the investment. Please note that the growth in Year 3 is only for calculating the NTM multiple at the end of runway. The template is based on 24 months runway.

This example follows the T2D3 formula (triple, triple, double, double, double). It assumes the company tripled ARR last year (€0.5m→€1.5m).

Burn multiple: A measure of capital efficiency and shows how many €’s are spent per €1 of ARR added.

2.0x is a relatively defensive assumption as companies need to invest for future growth and new structures need some time ramping up before pulling their weight. See also David Sacks’ article on capital efficiency.

Dilution: How much dilution the financing round will cause.

25% is typical, albeit again a perhaps slightly defensive (high) assumption.

NTM ARR Benchmark: For NTM multiples at the end of runway.

Again, you can use the BVP Cloud index for reference; make sure to set it to “Forward Revenue Multiple”. The median is currently around 5.0x.

Outputs

Given the aforementioned inputs, the company should raise €15.0m to reach €9.0m ARR in two years time. The dilution target sets the implied pre-money valuation at €45.0m or 30.0x (current) run rate ARR.

It is important to stress that this is not a statement on the “right” valuation for the company but rather its implied valuation given this scenario’s assumed growth, burn, and dilution.

A better indicator of whether this is a sensible valuation (for both entrepreneur & investor) are the 3.3x highlighted in pink. This metric shows the company’s Year 2 NTM ARR multiple vs. this financing’s post-money valuation at the end of this financing’s runway. It most closely corresponds to the “NTM ARR Benchmark” set earlier, i.e. 5.0x. Essentially, it shows whether the funds raised in this financing are used efficiently enough such that the company can grow into / outgrow its post-money valuation.

The left table above picks up the 3.3x highlighted in pink and shows a sensitivity analysis on the metric vs. growth and burn; or in other words: How will the 3.3x be impacted if the company is projected to grow faster / slower in Year 3 (= Year 2 NTM) or burns more money than expected meanwhile (in which case the runway naturally shortens from the assumed 24 months and the Year 2 NTM starting date is also pulled forward accordingly).

The right table takes the values of the left table and compares them against the set benchmark (i.e. 5.0x). It provides some visibility around “margin of safety”. For example, at a burn multiple of 3.0x and an expected growth rate of 50% in Year 3 the company’s post-money valuation would still be 23% above the current benchmark; meaning that the company would fail to grow into its Series A post-money valuation, making a structured or down-round in the following financing (if any) more likely.

So what

Given the assumptions above, I would argue that valuing a good Series A company at 30x current ARR is actually a sensible yardstick.

More important than market benchmarks (and even burn to some extent) is the degree of perceived certainty with which the company can continue to grow and compound at a significant rate.

Individual investor’ price sensitivity and risk appetite will depend on margins of safety vs. plan, expected uplift in the subsequent financing round, and defaults within the portfolio which need to be compensated for by performing companies.

Rather than providing and scrutinising particular assumptions, I wanted to share a tool with which you can challenge your assumptions — flying either too high or too low, each comes at a price. Happy modeling.

🤠 Download the valuation model here! (Note: Formatting will probably look best in MS Excel).

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