M&A for Small, Early Stage SaaS Companies
Guides provides things for small, early state SaaS companies to think about as they proceed with M&A
M&A is becoming more commonAccording to a Software Equity Group's recent report, First Quarter 2019's 277 SaaS M&A transactions marked another record quarter of deal volume. Small to mid-sized companies (less than 100 employees) continue to make up the majority of acquisition targets. Healthcare is the top field, followed by education, real estate and finance. As to products, there were significant transactions in content, document and business process management software and marketing and technology (martech) software.
The increase in M&A activity is driven by the fact that technology is a product-driven business. Products have cycles, and revenues track cycles. Therefore, technology companies are always looking to invent -- or acquire -- a new product on the growing side of its cycle. Synergistic M&A is necessary for existing players to remain competitive and grow. For smaller players, the end game is often a purchase by large strategics like MicroSoft or Salesforce looking to add to their platforms or by other product developers looking to expand their niche product offerings.
Traditionally, PE firms shied away from early-stage software companies in favor of later stage companies. They would then drive up profitability by cutting costs and inserting their own management. The end game was to sell or take the company public in a few years to generate a return. Now funds put capital into these companies to hire sales forces and improve and expand the platforms. This increased attention is good for SaaS companies as PE funds pay similar multiples as strategics. do.
M&A multiplesTo be an attractive candidate for M&A, a SaaS company should maintain at least 20% year over year growth with at least 90% of that revenue coming from contracted recurring streams. Recurring streams are key as profit in the future will expand materially as the business matures and spends less on development, sales and other costs. SaaS companies should strive for a 30%+ EBITDA margin. If you’re not profitable, growth needs to be well in excess of 20% to offset weaker EBITDA. Lastly, qualitative factors such as the age of the software, the necessity of the management team, customer acquisition cost, the uniqueness of the product and competition are taken into account .
Multiples for small, early stage SaaS businesses typically fall within the 2.5x to 4x revenue. 4x businesses are around 3+ years old, need less than 10 hours per week of the owner's time to maintain, have growing revenue and have lower customer acquisition cost. 2.5x businesses are less than 2 years old, need 20 hours or more per week of the owner's time to maintain, have steady revenues and require high customer acquisition cost. However, every business is unique.
On the other hand, I have seen multiples for established SaaS companies with synergistic, attractive customers receive multiples of 20x revenue, but such multiples require significant earnouts to realize full purchase price.
Now is a good time for a SaaS company to consider M&A while the industry is hot. Timing and speed are key as buyers have plenty of alterative companies to pursue to achieve similar objectives. This is especially true as a hot software solution today may be obsolete by new competition tomorrow.