15 Factors to Consider When Buying a SaaS Business Online
The SaaS industry is booming, with the global market projected to reach $883.34 billion by 2029 according to reports. Buying an existing SaaS business can help entrepreneurs bypass startup pains and tap into this explosive growth. But not all SaaS companies are created equal. Read on for the 15 most important factors to evaluate when acquiring a SaaS business online.
15 Key Factors to Consider When Purchasing a SaaS Business
1. Revenue and Growth
Revenue is one of the most basic but critical factors to examine when buying a SaaS company. Take a detailed look at the historical revenues:
Monthly and annual recurring revenue (MRR/ARR): This recurring revenue that can be counted on month after month is the lifeblood of any SaaS business. Review the trend of MRR and ARR over the past 1-3 years.
Growth rate: Analyze the rate of revenue growth over time. Expanding revenues show strong product-market fit and execution. Low or stagnant growth could indicate challenges.
Revenue retention: Look at net revenue retention rate. This metric shows the percentage of recurring revenue retained from existing customers. High retention reflects satisfaction and loyalty.
Customer churn: Churn measures how much recurring revenue is lost each month due to customers canceling. The lower the churn, the more predictable revenues.
Revenue stability: Subscription revenues should exhibit predictability and repeatability month-to-month with minimal surprises. Spiky or volatile revenues may indicate issues.
Customer segmentation: Breakdown of revenue across different customer cohorts, such as enterprise vs SMB, geography, industry etc. This indicates diversification of revenue sources.
Thoroughly understand the revenue makeup and trends. This will reveal the health and trajectory of the business.
2. Profit Margins
A company can generate revenues but how efficient is it at converting those revenues into profits? Gross margins should ideally be above 70% for SaaS. Review gross, operating and net profit margins over time using income statements.
Trends in margins will tell you about pricing power and cost management abilities. Watch out for declining margins which could indicate issues. Dig further to understand reasons behind any margin fluctuations like one-time costs or new investments.
Well-run SaaS companies should demonstrate strong and improving profitability to fuel further growth. Expenses also need to scale efficiently with revenues to keep margins steady.
3. Customer Retention and Churn
The subscription revenue model depends heavily on stable, recurring revenues from existing customers. Two key metrics related to this are retention and churn:
Retention rate: This measures the percentage of recurring revenue retained from existing customers over a period of time. For example, over the past 12 months. The higher the better.
Churn rate: The percentage of recurring revenue lost in a period due to cancellations or non-renewals. Typically also measured monthly and annually. Lower churn is better for predictable revenues.
A SaaS business with 90% annual retention and 5% annual churn inspires much more confidence in future revenues than one with 80% retention and 15% churn.
Poor retention and churn may indicate dissatisfaction with the product or brand. It could also reflect a demographic prone to turnover.
Understand the typical customer lifecycle and why customers leave. If the product and business are strong, retention and churn can potentially be improved once acquired.
4. Product and Technology
The product is the core value delivery mechanism of a SaaS company. You are acquiring customers, but importantly the product that services them. Assess:
Features: Does the product capabilities solve key pain points for target users? How does it compare to competitor offerings in the market.
User experience: Is the application modern, intuitive and easy to use. This impacts user adoption and retention.
Innovation: How often are new features, updates and enhancements released. Is there a clear product roadmap?
Scalability: Can the product support growth. Are there bottlenecks in the tech architecture that limit scale.
Reliability and uptime: Any history of outages, bugs or downtime incidents? Reliability is critical.
Security: How securely is customer data and privacy safeguarded? Examine if there are any vulnerabilities.
Technology stack: What languages, frameworks, databases and architectures are used? Evaluate technical debt and migration needs.
Development team: Size, skillsets and organization of current tech team. Are processes like code reviews, QA and project management employed?
While the product may not be perfect, ensure there is a strong foundation that positions the business for growth. Factor in required investments into the valuation.
5. Team and Talent
The team running a SaaS business is just as important as the product itself. Without a talented team, the company will struggle to execute and innovate.
Leadership: Evaluate the experience, strategic thinking and leadership abilities of the executive team. Do they have the ability to take the company to the next level?
Talent: Look at the overall competency, credentials, productivity and motivation of staff. How easy will recruiting and retention be?
Culture: Company culture and morale play a huge role in performance. Assess the workplace environment and tone set by leadership.
Org structure: Is there an efficient organizational structure in place to enable growth? Are there any gaps in key roles.
Compensation: Review compensation packages, equity incentives and employee satisfaction. This has an impact on retention and motivation.
Remote or in-person: Determine if the team is fully remote or works out of a central office. Both models have tradeoffs to understand.
The ideal scenario is acquiring a business with an experienced, motivated team across departments like technology, sales, marketing, customer service and operations. Avoid scenarios where a full sweep of the org chart is required post-acquisition.
6. Financial Documents
Due diligence requires taking a deep dive into accounting records. Request and scrutinize audited financial reports including income statements, balance sheets and cash flow statements over the past 2-3 years minimum.
Understand the company’s accounting practices, internal controls and bookkeeping software used. Watch for inconsistencies across documents. All documents like tax filings should align and tell a consistent financial story without red flags.
Complete understanding of current financial position is critical for forecasting and estimating purchase multiples appropriately. Quality financial data helps discover both hidden gems and skeletons in the closet.
7. Customer Base
Examine the customer segmentation, average size and industry spread. Over-reliance on a major customer poses concentration risk. Broad diversification is preferable for stability.
Check major clients’ contract expirations, renewal schedules and expansion abilities. Predictable recurring revenue depends on retaining high lifetime value customers. Request sample contracts and terms too.
Assess overall churn rates by customer segment. Customers following specific profiles may churn more such as smaller payers or certain industries. Retention levers can then target such segments strategically.
Healthy recurring revenue depends on low-churn, sticky customers. Customer data insights reveal true underlying business strengths and retention opportunities.
8. Marketing and Sales
Sales is the lifeblood for acquiring new customers and keep existing ones engaged. Map out full sales process, collateral, pipelines and predictable new client volumes. Marketing should produce reliable new leads volume.
Gauge typical new customer acquisition costs (CAC) and expected payback periods. Benchmark against industry standards. CAC metric links closely to ideal customer profile and pricing.
Sales projections across channels build forecasts, but real data proves capabilities. Request sample marketing campaigns, lead generation results, closed-won deals to assess true sales machine efficiency and headroom for growth.
Without a strong demand engine, recurring customer streams will plateau or decline over time affecting valuation multiples significantly.
9. Contracts and Licensing
Access sample customer contracts, SLA’s, support terms etc. to gauge commercial and operational strengths. Review customer renewal and expansion levers built into engagements. Standard or customized contract suites?
Evaluate licensing and pricing models flexibility. Room for premium up-sells or allowance for flexible downgrades? Understand default renewal periods and notice terms.
Assess ability to monetize effectively by adding modules, users or premium SaaS plan features routinely. Predictability depends on retention combined with recurring expansion revenue from existing accounts over time.
10. Due Diligence Process
A comprehensive diligence necessitates full access to all key documentation, agreements, customer/partner references and financial records with ample time for review and follow-up queries.
Request to directly speak with select customers representing different segments to assess real product satisfaction and stickiness factors.
Background checks of founders along with scrutiny of past deals, partnerships and M&A record helps calibrate inherent risks. Final purchase depends on mitigating open items uncovered.
Sellers should transparently provide all requested materials without restriction and agree enforceable deal contingencies up-front.
11. Valuation and Deal Terms
Information asymmetries exist, so sellers will inflate perceived value. Prepare independent forecasts to estimate fair implied multiples based on defensible growth projections and comparables.
Consider goal alignment with earn-outs linked to post-close performance milestones. Weighing upfront cash against back-ended payouts optimizes risk-adjusted returns.
Representations, warranties and indemnities safeguard against future liabilities. Ensure appropriate protection clauses covering undisclosed risks. Any inherent business weaknesses impact valuation multiples significantly.
12. Regulatory Landscape
Check for specific industry regulations or data privacy/security compliances like GDPR impacting operations. Evaluate compliance costs and maturity currently.
Future-proofing necessitates continuous innovation within evolving compliance environment. Consider changing regulatory tailwinds or headwinds also.
Special licenses required? Consult experts regarding regulatory burdens post-acquisition also. Non-adherence risks reputational damage, monetary penalties or hampered growth opportunities.
13. Competition
Map competitive landscape against target customer segments to gauge relative product differentiation and positioning strengths. Assess direct rival solutions, features and pricing.
Consider consolidation trends within the solution category. Rising pressure could compress margins, or acquiring competitive technology may supplement existing offering.
Evaluate barriers upholding any sustainable competitive advantage factors underpinning repeatable growth such as network effects, data assets or brand loyalty generating pricing power and profitability.
14. Roadmap and Vision
Evaluate 1-3 year product evolution plans aligning with broader market outlook. Validate any assumptions regarding new markets, adjacencies, data/AI integrations etc with objective third-party insights.
Assess budget allocations across functions to deliver planned roadmap. Ensure sufficient resources for scaling existing strengths before venturing into high risks areas.
Consider management’s track record and conviction level in previously articulated strategies. Vision should create real quantifiable value and not empty promises preserving status quo.
15. Operational Efficiencies
Evaluate infrastructure needs against headcount, costs and scalability to support multi-year targets. Potential for productivity gains and outsource-able functions reduce risks.
Right-size operations to balance growth, profitability and risks. Cost optimization combined with scalable infrastructure upgrades remain important for healthy margins as business scales up exponentially.
Conclusion
Buying a SaaS business can be a shortcut to growth, recurring revenues and profits when done right. But failing to evaluate all these key factors can lead to major pitfalls down the road. Conduct thorough due diligence across these 15 areas before signing a deal. With the proper diligence, acquiring an existing SaaS business online can set you on the path to success.
