Today’s Formula Behind Software M&A Exit Multiples

An exit multiple is a standardized way of comparing the valuations of different companies when sold. There are various exit multiple formulas, but valuation is often expressed as a factor of earnings before interest, taxes, depreciation, and amortization (EBITDA). For example, if a company with EBITDA of $1 million was acquired for $10 million, the exit multiple would be expressed as 10x EBITDA.

Company founders and potential buyers keep a close eye on the exit multiples of M&A transactions around the industry, because it gives them a better idea of how much their company could sell for, or (in the case of a buyer) what constitutes a competitive offer.

But just because a similar company sold for a certain multiple doesn’t mean your company will. There are many factors that determine how highly buyers will value a potential acquisition, so it pays to understand more about what they’re looking for and how you can make your business more attractive.

What Variables Determine Your Company’s Exit Multiple?

Generally speaking, exit multiples (and thus valuations) can be impacted by a mix of external and internal factors. External factors include those that are largely out of your company’s control, such as the overall state of the economy, the software industry, and vertical markets.

Variable #1: Macroeconomics

As for the economy, the story of 2024 is mostly good news. Interest rates remain higher compared to a few years ago, but they are still within historical norms and have stabilized over the last year as inflation has abated. The job market is strong, GDP has grown faster than expected, and the public stock market has performed well in recent months. These factors tend to be leading indicators for the SaaS M&A market, so we are optimistic about the second half of 2024.

Variable #2: Current Demand

Demand is already especially strong for SaaS companies that meet certain criteria, and this is where internal factors come into play—things your company has the power to change. According to SEG’s most recent buyer survey, the software companies in highest demand are those with mission-critical applications (making them indispensable to their customers) and solid products with robust functionality. These qualitative factors aren’t easy to measure, but present opportunities to SaaS founders, nonetheless.

Variable #3: Company Metrics

In terms of quantitative metrics, our survey revealed that today’s buyers place the most value on gross revenue retention: proof of a company’s ability to sustain a loyal customer base. Their second-most important metric was gross profit, demonstrating a company’s capital efficiency. Read more about these two key metrics here. Lastly, revenue growth is another important factor, and while rapid growth is always viewed favorably, buyers emphasized that it shouldn’t come at the expense of stability and profitability.

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How to Strive for a Higher Exit Multiple

Digging deeper into factors your company can control, there are many different ways SaaS businesses can position themselves to achieve the highest possible exit multiple.

Start with Unit Economics

One key area to focus on is improving unit economics. Unit economics is the collective term for a set of metrics that helps SaaS businesses understand and optimize their spending to achieve more profitable growth. Having strong unit economics means the company is targeting and winning the right customers efficiently, without burning through cash so quickly as to undermine profitability. These are attractive qualities that can help convince buyers to pay a premium for your company. Learn more about unit economics here.

Assess Your Company’s 20 Factors

Also be sure to review SEG’s 20 Factors to Track When Valuing Your Software Company. Through many years of experience working with SaaS businesses, we’ve created a scorecard of 20 metrics—a mix of qualitative and quantitative factors—that provide a clear picture of a company’s strength and impact its valuation. In our advisory role, SEG uses this scorecard to help determine a company’s readiness for exit.

For example, the scorecard below shows how a hypothetical company scored on each of our 20 Factors. To summarize, the numbers reveal that the company has a high growth rate fueled by significant investments in sales and marketing but has a low customer lifetime value (LTV) to customer acquisition cost (CAC) ratio. With its high rate of cash burn, the company is currently sacrificing profitability in the name of scaling up rapidly (a common scenario for younger SaaS businesses). From this data, we can conclude that this isn’t the best time for the company to pursue an exit event. But with time, it can grow into its sales and marketing investment, reach a critical mass of customers to enhance efficiency, and become a more attractive M&A candidate.

Know When to Go to Market

Assessing the right time to go to market is just one way a sell-side M&A advisor can help you increase your exit multiple. When it comes time to hit the market, an experienced advisor can also add value by helping you present your business in the best possible light, and by bringing more buyers to the table to create a competitive bidding process. As the offers come in, the advisor can help negotiate the most favorable terms.

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What Exit Multiple is Possible for Your Company?

As we’ve discussed, the exit multiple your company receives in an M&A deal will depend heavily on its financial performance. But assuming your company is achieving profitable and sustainable growth, it is reasonable to look at other deals in the industry as a barometer of what to expect.

There are various ways to calculate exit multiples. One of them, mentioned earlier, is the multiple of EBITDA. Other common multiples look at the company’s Revenue or the Seller’s Discretionary Earnings (SDE). SDE is typically used for smaller businesses and measures the financial benefit of the business to a single owner-operator.

Based on publicly available data compiled by FirstPageSage, here are some average 2024 SaaS exit multiples by industry. We’ve listed verticals where SEG has the most experience.

A Few Exit Multiples by Sector

Source: FirstPageSage

Explore Your Company’s Valuation Potential

Even with extensive research, deciding on the right time to sell and navigating the negotiating process can seem overwhelming for many business owners. As a sell-side advisor with decades of experience and deep expertise in the software field, SEG is here to help your company on its path to an exit event. Our expert advisors work to understand your business and recommend critical steps to improve your exit multiple with satisfactory terms. Reach out today to start the conversation.

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