Podcast Summary: The Path to Exit - Episode 24 | The Subjectivity of Valuation in SaaS M&A

Introduction

In Episode 24 of The Path to Exit, hosted by Mike Lyon of Vista Point Advisors, the discussion delves deep into the nuanced and often misunderstood realm of valuation in Software as a Service (SaaS) mergers and acquisitions (M&A). Joining Mike is Scott Austin, Managing Director at Vista Point Advisors, who brings extensive experience advising SaaS businesses on capital raises and M&A transactions. This episode unpacks why valuation in M&A is inherently subjective, explores the varied perspectives of different buyers, and provides strategic insights for founders navigating the complex landscape of selling their tech businesses.

Valuation: Subjective vs. Objective

The episode begins by challenging the common misconception that business valuation is a straightforward, formulaic process. Mike Lyon emphasizes, “valuation is in the eye of the beholder” (00:19), highlighting that multiple factors influence how a company's worth is perceived by different buyers. Unlike public companies, which are subject to daily market valuations and extensive analysis, private SaaS businesses lack comparable benchmarks, making their valuation more fluid and dependent on the buyer's perspective.

Types of Buyers and Their Valuation Approaches

Scott Austin elaborates on the diversity of buyers in the SaaS M&A landscape, explaining that each type—strategic buyers, private equity (PE) firms, and private equity-backed strategics—has distinct valuation methodologies. “[Different buyers have different] ways that companies are acquired, which presents a bunch of different opportunities” (01:40).

• Strategic Buyers: Often value businesses based on how the acquisition aligns with their strategic initiatives, such as expanding their product suite or entering new markets. However, their valuation can fluctuate significantly based on whether they see the business as a strategic fit or merely an asset to be integrated cost-effectively.

• Private Equity Firms: Tend to take a longer-term view, focusing on the addressable market and potential for growth, retention metrics, and profitability. Their valuation approach is influenced by their investment horizons and the specific mandates they have towards their limited partners (LPs).

Challenges with Public Company Comparisons

Mike warns against using public companies as direct comparables for valuing private SaaS businesses. He notes, “there’s logic in how public companies are valued, but it can be really dangerous” (03:33). Public companies often enjoy scale and slower growth rates, which can distort valuation metrics when applied to smaller, rapidly growing private firms. This discrepancy arises because public entities can afford to grow incrementally with larger resources, unlike their private counterparts that might be scaling quickly with more agility.

Differences in Information and Buyer Evaluation

A critical factor in valuation subjectivity is the difference in information available to buyers. Scott shares anecdotes illustrating how nuanced buyer motivations and internal strategies can dramatically influence valuation outcomes. For instance, when Vista Point Advisors sold Software Advice and Capterra to Gartner, they initially underestimated Gartner's strategic interest, only to discover later that Gartner saw significant synergy in the acquisition (03:33).

Furthermore, Scott points out that buyer strategies can evolve, as seen when Dropbox shifted its priorities post-COVID from growth to cash flow, altering its valuation stance unexpectedly (05:14).

Valuation Differences Among Buyers

The conversation highlights how valuations can vary widely even within similar buyer categories. Scott cites an example where a private equity-backed company valued businesses at 10x Annual Recurring Revenue (ARR) multiples in one context but adjusted drastically once the company went public, trading at 56 times revenue (06:29). This fluctuation underscores the impact of a company's structural and financial changes on its acquisition valuation.

Private equity firms, in particular, exhibit significant variation in their valuation approaches based on their investment strategies and the specific sectors they focus on. Scott explains, “whether they're trying to pursue lower gross margin businesses that they can buy in the four to six or seven times revenue range versus some of the brand names out there willing to pay 10 to 20 times revenue multiples” (07:50).

Who Pays the Highest Price? Strategic vs. Private Equity Buyers

Determining which buyer will offer the highest valuation is no longer a straightforward decision favoring strategic buyers, as was commonly thought a decade ago. Mike outlines scenarios where strategic buyers may offer higher valuations due to true synergies, such as product fit and cross-selling opportunities. For example, he recalls a fintech business sale where the prevailing buyer valued the business significantly higher due to licensing synergies (08:04).

Conversely, top-tier private equity firms can contest strategic buyers' valuations if they perceive unique growth opportunities or have lower risk assessments, allowing them to bid competitively. Mike advises founders to recognize that both strategic and PE buyers can be highly competitive, depending on the specific circumstances and perceived value alignments.

Pattern Recognition in Private Equity Firms

Scott delves into the concept of pattern recognition within PE firms, explaining that past successes or failures in specific sectors heavily influence their willingness to invest. “If there is a partner at a private equity firm... who made a killing with a compliance or tax software business before, you can imagine that the next time an attractive business in that sector comes around, they're more than able to justify paying a higher multiple” (12:27). Conversely, negative past experiences can deter PE firms from investing in similar sectors, regardless of the current business's potential.

This behavior often leads to "herd mentality," where successful transactions in a particular vertical prompt a flurry of similar acquisitions as firms seek to replicate past successes (13:16).

Risks of Assuming Buyer Behavior

A significant risk in the valuation process is the assumption that certain buyers will behave in predictable ways. Mike and Scott caution against relying too heavily on past perceptions of buyer behavior, as internal changes within buyer organizations can lead to unexpected shifts in their acquisition strategies. Mike shares a recent experience where a seemingly low-bidder suddenly increased their offer last minute, illustrating the unpredictability of buyer valuations even in advanced stages of the transaction (14:04).

Scott adds that unforeseen discussions or strategic shifts within buyer firms can dramatically alter their interest and valuation, emphasizing the importance of maintaining flexibility and not limiting the search to preconceived buyer lists (15:41).

Conclusion

Episode 24 of The Path to Exit provides invaluable insights into the complexities of valuing SaaS businesses in the M&A arena. Valuation is depicted not as a rigid formula but as a multifaceted, subjective process influenced by the diverse perspectives of potential buyers. Founders are encouraged to:

• Understand the Diversity of Buyers: Recognize that different types of buyers will approach valuation from various angles, whether strategic synergies or growth potential.

• Avoid Simple Comparisons to Public Companies: Use caution when benchmarking against public firms, as scale and growth dynamics differ significantly.

• Remain Flexible and Open-Minded: Stay adaptable throughout the sale process, being open to unexpected buyer interest and valuation shifts.

• Leverage Buyer Insights: Engage in thorough discussions with potential buyers to uncover their true motivations and valuation drivers.

By navigating these subjective elements thoughtfully, founders can optimize their strategies to achieve favorable valuations, ensuring a successful exit from their SaaS ventures.

Notable Quotes

• Mike Lyon (00:19): “Valuation is in the eye of the beholder... it’s not the same as what any one buyer will pay for it.”

• Scott Austin (01:40): “Different buyers have different ways that companies are acquired, which presents a bunch of different opportunities.”

• Mike Lyon (03:33): “Using public companies as a valuation comp can be really dangerous... typically those businesses are a lot bigger.”

• Scott Austin (06:29): “Private equity firms are making platform investments... they have different valuation metrics based on growth, margins, retention.”

• Mike Lyon (08:04): “Strategic buyers might offer higher valuations if they see true synergies... but top-tier PE firms can also bid competitively based on growth potential.”

• Scott Austin (12:27): “Pattern recognition... if a partner at a PE firm succeeded with a software business before, they’re likely to pay a higher multiple next time.”

• Mike Lyon (14:04): “Assuming you know who's going to prevail can be very dangerous... being thoughtful but nimble is the way to get the best valuation.”

About Vista Point Advisors Vista Point Advisors is a founder-focused investment bank specializing in advising software and internet founders through M&A and capital raise transactions. As a fully unconflicted investment bank, VPA exclusively represents the interests of founders on the sell-side, ensuring unbiased and dedicated advisory services. For more information, visit their For Founders section.