Tips for Acquiring a SaaS Business

With a market value worldwide of $390.50 billion and an expected growth rate of nearly 20%, the Software as a Service (SaaS) market is positioned for a positive explosion in the coming years. 

While starting a SaaS business from scratch can be expensive and take a while to get a foothold in the market, acquiring an existing business can be a lucrative investment.

Before you buy a business, though, there are a few things you’ll need to know.

Understanding the SaaS Business Model

The business model for SaaS companies varies from that of other types of tech companies.

Rather than rely on selling products one at a time, SaaS companies use a subscription-based model. New customers are automatically billed each month for software services, with the option to save money if they pay for an entire year at once. This model offers predictable cash flow and recurring revenue.

Some SaaS models attract users with free plans and monetize through upgrades. This offers a no-risk opportunity to try the platform before committing financially.

Because there’s nothing to physically build or ship, costs to scale are minimal, making it easy to grow quickly. And once the software is built, it virtually costs nothing to add another customer. Most SaaS platforms offer automated services for clients, which means the company doesn’t have to spend much on customer service reps to guide customers through the purchase process.

What to Consider Before Buying

Just like buying any type of business, you’ll want to know exactly what you’re looking for and examine each potential business carefully.

Start by defining your goals. Are you looking for a business in which you will oversee day-to-day operations? Or do you want a source of passive income?

What gaps are there in the market? With technology rapidly evolving, there’s constantly a space for innovative solutions.

Once you’ve identified a particular niche you’re interested in, examine the demand, industry trends, and key competitors.

And finally, know your audience. Who buys this type of software? What are they looking for? How long do they stay with a company? In what ways are they dissatisfied with existing solutions?

Do Your Due Diligence

Don’t discount the importance of doing your research on the company you’re considering buying. It’s not always the case, but sellers tend to put their business in a positive light, even if it’s struggling financially. It’s your responsibility to find out everything you can about this business and to ask the right questions.

Financial Due Diligence

Start by asking to see financial statements like the balance sheet and cash flow statement. Ask questions about the company’s revenue streams (subscription models, upsells, enterprise deals).

What are the profitability and cash flow trends over time? How does the current owner account for any dips in profitability (this might happen seasonally or during economic downturns)?

What costs does the business have, including fees for infrastructure, marketing, support, etc.?

Technical Due Diligence

If you’re not tech-savvy, bring someone with you who is. You need to understand how the software works, what systems are in place to maintain the security of customers’ sensitive information, what hosting infrastructure the company uses, and how it scales. You will also want to know the company’s ongoing costs regarding software, maintenance, and regular updates.

Operational & Legal Due Diligence

Ask about existing contracts with customers, vendors, and employees. How long are they? 

How does the company comply with data protection regulations (GDPR, CCPA)? What intellectual property (IP) and patents does the company own? Will they be included in the sale?

Choose a Valuation Method

Now you’ll want to determine whether the asking price is a valid value or not for the business you’re considering buying. 

There are several valuation methods available, so choose the one that best fits your needs.

The revenue multiple method is most common for SaaS companies. It creates a value based on a multiple of the business’ Annual Recurring Revenue (ARR) or Monthly Recurring Revenue (MRR).

There’s also the discounted cash flow (DCF) method. It estimates the future cash flow a SaaS business will generate and discounts it to present value. It’s most commonly used for profitable SaaS businesses with stable cash flow.

Consider also the EBITDA multiple method. It measures profitability by looking at Earnings Before Interest, Taxes, Depreciation, and Amortization.

The user-based valuation focuses on the Customer Lifetime Value (LTV) and Customer Acquisition Cost (CAC).

You might decide to use a combination of these methods to find a fair valuation of the business.

Put On Your Negotiation Hat

Especially if you find that the asking price is higher than the valuation you’ve calculated, you’ll want to negotiate for a better price. 

Identify leverage points to negotiate. Look at the churn rate, which is the percentage of customers or revenue lost over a specific period. A high churn rate (10-20% or higher) may mean the company isn’t currently doing a good job at keeping customers, and you may be able to lower the purchase price as a result.

Also look at growth rate, which is a major indicator of a solid customer acquisition strategy and market demand.

Customer concentration is another point to look at when preparing to negotiate. If a handful of customers generate most of the revenue, this is risky since losing even one customer would cause a drop in revenue.

Your negotiation strategy might include more than simply asking for a lower price. You can also negotiate how the deal is structured. For example, you might ask for an earn-out option rather than making an upfront payment for the purchase. The acquisition price can be split into an initial payment and then performance-based payouts over time.

Earn-outs are typically based on hitting specific revenue, profit, or customer retention targets post-sale.

You can also mitigate risk by asking for seller financing so that you pay in installments over time. You’d pay the seller interest on the payments, which are usually structured over 12 to 36 months.

You can ask for contingencies, which are conditions that must be met before the deal is complete. These contingencies might be tied to financial performance, customer retention, or contractual obligations.

Making a Smooth Transition 

The hard work doesn’t stop once the deal is done. As the new owner, it’s your responsibility to make sure that the transfer of ownership is smooth and not disruptive to staff.

Onboarding & Knowledge Transfer

Work with the previous owner/founder for a smooth transition of knowledge. Ask for clearly documented processes that you need to have a handle on, including customer support, DevOps, and leadership responsibilities.

Spend weeks shadowing the owner so you can see what the day-to-day looks like.

Team & Customer Communication

Understandably, employees may be a little nervous that there will be big changes that will impact them. Do your best to communicate that their jobs are safe, and be transparent about what will change. It’s your goal to instill trust in your new employees.

Scaling & Optimization

You likely have ideas about how to make your new acquisition better. Start with quick wins that will be easy to implement, like updating the pricing strategy and identifying upsell opportunities.

Next, move on to brainstorming ideas for customer retention and reducing churn.

Finally, explore new marketing and sales strategies for growth. Include key employees in the brainstorming sessions since they may have great ideas that can help the company scale quickly.

Common Pitfalls to Avoid

When you’re excited about the prospect of taking an existing SaaS company and making something even greater, you may be tempted to skip over the due diligence process. Don’t. A business may look great from a distance, but the closer you get, you may see issues that you will inherit as the next owner.

The tech space is a competitive one. Underestimating how difficult it is to retain customers is a mistake you want to avoid. Spend time studying the industry and the business’ competitors to understand customers and what motivates them. Are they price-sensitive and likely to switch providers if there’s a cheaper option? What features make them loyal?

Acquiring a SaaS company presents a great opportunity to elevate an established business. However, it’s important to recognize the potential challenges that come with such a purchase. Do your research to identify any possible issues so you can be fully prepared to address them.