Understanding Private Equity Investors: How SaaS Firms Are Evaluated

Introduction: Private equity investors play a significant role in the growth and development of SaaS firms. To navigate this landscape successfully, Sellers need to understand the metrics and criteria used by private equity investors to evaluate SaaS companies. In this article, we will dive into the key factors that private equity investors consider when assessing the value of SaaS firms, providing valuable insights for Sellers looking to attract and engage potential investors.

  1. Revenue Growth and Market Share: Private equity investors closely examine a SaaS firm’s revenue growth rates and market share as key indicators of its potential. Impressive revenue growth demonstrates the ability to attract and retain customers, while a substantial market share signals dominance in the industry. Sellers should showcase their growth strategies, competitive advantages and market penetration to pique the interest of private equity investors.
  2. Recurring Revenue and Customer Base: Recurring revenue is a critical metric that private equity investors focus on when evaluating SaaS firms. This metric represents the predictable and recurring monetary value derived from customer subscriptions or contracts. Sellers should highlight their Annual Recurring Revenue (ARR) and Monthly Recurring Revenue (MRR) figures, as well as emphasize customer diversification to demonstrate stability and long-term revenue potential.
  3. Revenue Concentration is another key evaluation metric as private equity firms typically prefer companies with lower revenue concentration because it reduces the risk associated with relying heavily on a few customers. If a significant portion of a company’s revenue comes from a single customer and that customer decides to switch suppliers or experiences financial difficulties, it can have a substantial negative impact on the company’s financial performance.
  4. Total Contracted Revenue (TCR) and Total Contract Value (TCV): Private equity investors assess the total contracted revenue to gauge the financial commitments from customers over the contract duration. Sellers should emphasize the TCR as it showcases the revenue visibility and predictability of the business. Additionally, TCV, which includes one-time charges for professional services, setup, and training, can provide an accurate representation of the value delivered to customers.
  5. Billings as a Growth Indicator: Billings serve as a crucial metric for evaluating the growth trajectory of a SaaS firm. Private equity investors analyze billings to gain insights into new customer acquisitions, upsells, renewals, and overall revenue growth potential. Sellers should emphasize their ability to drive billings, showcasing their sales strategies and customer expansion efforts.
  6. Gross Profits and Margins: Private equity investors consider gross profits and margins to evaluate a SaaS firm’s profitability and scalability. Sellers should highlight their ability to achieve high gross margins, ideally around 80%, as it demonstrates efficient cost management and potential for sustainable growth.
  7. Cash Management and Burn Rate: Efficient cash management is crucial for SaaS firms, particularly in terms of burn rate and cash flow generation. Private equity investors carefully assess a firm’s ability to manage cash effectively and achieve profitability. Sellers should highlight their cash management strategies, showcasing their ability to navigate the upfront investment needed to build out a SaaS platform and the ongoing capital expenditures required to maintain them.
  8. Customer Lifetime Value (CLTV) and Customer Acquisition Costs (CAC): Private equity investors consider CLTV and CAC to assess customer acquisition efficiency and the long-term value generated from customer relationships. Sellers should emphasize their CLTV figures, demonstrating the profitability of their customer base, while also showcasing their effective CAC management to attract potential investors.

Conclusion: Understanding how private equity investors evaluate SaaS firms is crucial for Sellers seeking investment opportunities. By focusing on revenue growth, market share, recurring revenue, customer base, total contracted revenue, total contract value, billings, gross profits, cash management, customer lifetime value, and customer acquisition costs, sellers can present a compelling case to potential investors. Emphasizing these key metrics, along with transparent financial reporting and accurate data capture, will help sellers attract the attention of private equity investors and maximize the value of their SaaS firm.

Jon Hart and Steve Wasylenko