5 Key M&A Market Readiness Indicators for SaaS Companies

Q1 2024 Analysis

Market in brief

Last year proved volatile for mergers and acquisitions. A post-pandemic slowdown in deal volumes and the rising cost of debt changed the dynamics for companies headed to market for capital formation transactions and buy-outs.

The news is not altogether bleak. Investor interest is holding strong. Private equity firms alone are sitting on nearly $900 billion in dry powder, which they are eager to put to good use. Given economic uncertainty and global unrest, however, many investors have remained cautious about the types of deals they pursue.

We’re witnessing an interesting result in the deals we’ve been negotiating, as well as in our regular surveys of and conversations with hundreds of institutional investors: a flight to quality.

Competition for the most attractive mid-market companies is keen, driving up multiples for best-in-class businesses. Factors such as size, ARR retention, revenue growth, margin profile, and a proven management team are enhancing multiples and deal certainty. Valuations for top- and bottom-quartile deals are stretching further apart.

What does this mean for SaaS companies? The opportunity to buy predictable and growing revenue streams has sustained investor enthusiasm, with revenue multiples in the double-digit range well within the realm of possibility for the best targets.

How can you tell if yours is a business that would have today’s buyers salivating? Following are five factors most investors will examine closely.

Strengths to leverage

Three SaaS value drivers currently catching investors’ attention include:

  • ARR GROWTH (or MRR): Growth of recurring revenue, which can be calculated annually or monthly, is the name of the game for SaaS companies. ARR growth of 30% or more will amp up buyer excitement.
  • INCREMENTAL GROSS MARGIN PERCENTAGE: Divide gross margin dollars generated by a new customer in the first year by the revenue dollars for the customer in the same year. If the result is over 80%, that’s a positive sign to investors, as it enables quick scaling without significant capital infusion.
  • PROFITABILITY: Many SaaS companies are investing heavily in product development, people, and marketing and, therefore, have limited profitability. Nonetheless, those companies that can show strong revenue growth paired with 20% or higher EBITDA margins will attract strong interest.

Cause to pause?

Unfortunately, certain weaknesses are more likely to worry investors in the current environment. Be on the lookout for:

  • REVENUE CHURN: Losing customers is never a good thing. These days, investors are typically reluctant to pursue companies with churn rates exceeding 5% per year, and best-in-class enterprises achieve negative churn.
  • LTV/CAC RATIO: What is the average lifetime value of a customer, and how much does it cost to acquire one? If the ratio is under 2, a company may find it difficult to get a deal closed. Reach 4 and above and the picture changes substantially.

No business is perfect. A single problematic metric shouldn’t deter owners of an otherwise excellent company from exploring the market. A growing SaaS enterprise with a respectable showing on the five factors above could find today’s market ripe for a prime valuation.

Not checking enough boxes? The good news is that focusing on these fundamentals makes sense, even if you’re years away from a potential transaction.

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About the Authors

As Managing Partner at Class VI, Zack Gibson oversees the investment banking division. In his 15 years with the firm, Zack has been part of transactions totaling more than $2.5 billion spanning a wide range of industries, from technology to consumer products to manufacturing.

Matthew Petterson is a Vice President at Class VI. He has advised companies in a variety of industries, including several software and technology businesses in the cybersecurity, weather data, healthcare, and enterprise software verticals.