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How To Perform Due Diligence While Acquiring A SaaS Business?
due diligence 1

 

Studies suggest the SaaS market will likely reach $436.9 billion by the end of 2025. It is evident from this statistic SaaS is a fast-growing and evolving industry. With the unprecedented growth of the SaaS industry, many VC firms are increasingly acquiring SaaS businesses. For this reason, we have decided to nail down all the metrics for due diligence while acquiring a SaaS business.

As a savvy tech entrepreneur, you must want to enter into this multi-billion dollar industry because, in this way, you can earn behemoth returns over your seed investment. Eventually, you can achieve financial freedom in your life.

There the real irony lies. How do you perform due diligence while buying a SaaS business? Before we delve deeper into our main topic, we first let you know some key statistics of the SaaS business.

SaaS Business Statistics

  • The usage of SaaS-based apps is growing at a rate of 30% YoY.
  • 73% of all the large enterprises strongly believe that majority of their business apps will be SaaS-based in the upcoming years.
  • SaaS expenditure of all the businesses, either small or large, has gone up dramatically in the last few years.

What is a SaaS Company?

The emergence of the fourth industrial revolution has drastically changed how people do business. The advent of cloud-based infrastructure has triggered the digital transformation worldwide, leading to unprecedented growth of the SaaS business model.

Simply speaking, SaaS Company is an enterprise that harnesses software to provide computational service to its clients based on the pay-as-you-go model.

SaaS Companies first develop their product and grant access to the product to their customer at a very reasonable price. This price is known as a subscription charge. SaaS Companies offer different subscription plans with varying customer support, features, and add-ons.

Furthermore, it is the responsibility of SaaS Companies to upgrade too often, upgrade the servers and ensure security compliance. Some of the well-known SaaS products that businesses commonly use are Grammarly, Hubspot, Mailchimp, Salesforce and Dropbox.

Benefits of SaaS Business Model

Due to the increasing reliance of businesses on SaaS-based apps, SaaS has a bright future. It has a plethora of benefits; the most prominent of them all is:

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Scalability

SaaS business can scale up quickly, and it doesn’t put any unnecessary pressure on your scarce resources while you are scaling up. As your customer base expands, the cost of servicing individual customers goes down dramatically.

Flexible Licensing

The SaaS-based subscription model can fulfil customers’ needs more effectively than a one-off payment model. Moreover, the adaptability it provides customers is unavailable in on-premise hosted solutions. 

On top of that, SaaS offers flexible monthly, quarterly, or annually subscription timeframes that can be paid as required without requiring a customer to purchase the physical hardware to host the software.

Predictability of the Revenue

SaaS business revenue is predictable because the customer has to bear an exorbitant switching cost for cancelling the SaaS subscription plan.

High Buyout Potential

Due to the consistent revenue and a proven business model, you can quickly sell your running SaaS business to anyone. Unfortunately, that’s not the case with product-based companies.

Considerably Low Maintenance and Management Costs

SaaS business turns out to be more e efficient in terms of cost and time when updating new features than on-premise software. With on-premise software, you need to deploy more technical experts, and your technical experts have to devote more teams just to perform a slight upgrade.

When it comes to cost, most SaaS applications can be deployed at a high-speed and minimal cost compared to the traditional on-premise hosted software. Besides, there will be a considerable saving of infrastructure and maintenance costs.

If you want to acquire a growing SaaS Company, you need to perform due diligence while buying a SaaS business. By the end of this article, we’ll equip you with all the essential information that assists in purchasing a lucrative SaaS business.

Buying an Existing SaaS Business Vs Starting Your Own

When you think of entering into a SaaS industry, you have two main options: creating your own company from scratch or buying an existing one.

Which Route Best Suits You?

There are many factors to consider when figuring out the answer to this question. However, being an investor makes more sense to buy a SaaS Company than to establish yours. Here are the reasons why:

Save Time

Buying an established SaaS business saves a lot of time that would otherwise have been wasted on product research, marketing, and development.

Additionally, you no longer have to devote your time and resources to market a SaaS product. By buying a SaaS product, the time and money required to market a product reduce significantly as the product is already launched and has an established customer base.

Saving of Funds

When creating a SaaS Company, a lot of money has been wasted on research and development and at the product development stage of a SaaS product. By buying an established SaaS Company, you don’t have to burn a lot of your cash just to develop, upgrade, or configure a SaaS product.

You Don’t Need to Learn Coding.

 For starting a SaaS business, you have to be somewhat comfortable with the coding skills. In stark contrast to that, buying a SaaS business doesn’t require you to have any coding skills at all.

Even though, when creating a SaaS product, you can hire the best developers who can convert your idea into a lucrative solution. However, you need to invest enormous time and money to accomplish this task.

What to Consider While Acquiring a SaaS Company?

Undeniably, tech companies are gold companies if we harness their true potential. As every industry is undergoing digital transformation, the demand for SaaS products is growing at a dizzying pace.

Nevertheless, not all SaaS businesses are lucrative because their business model does not address the users’ requirements. So, as a tech investor, you need to be extra cautious when acquiring a SaaS Company. Here are the few actionable you should consider while buying a SaaS business.

SaaS Company Business Model

due diligence while acquiring a SaaS business

 

The first step in due diligence while buying a SaaS business is understanding its business model.  SaaS business model is different from the traditional business model in that a customer does not only pay for the subscription-only one time.

Conversely, there are many ways SaaS Companies owners can generate recurring revenue for their business. Here are some of the prominent and well-established revenue sources for the SaaS Company.

  1. Subscription

The subscription is the primary and the most effective revenue source for all SaaS Companies. It includes charging monthly, quarterly, or annual fees for consuming your service.

To keep that in perspective, let’s take the example of the well-known SaaS Company Hubspot. As we have already discussed revenue recognition model in SaaS is utterly different from the one-time payment model of traditional businesses. 

In a SaaS business, revenue is only recognised when the service is consumed. In this model, if the customer purchases an annual subscription plan, revenue cannot be recognised until the customer has rendered the service.

Now let’s try to understand this fact with an example.

Suppose a customer purchases an annual subscription plan for $100 per month. The $1200 revenue cannot be recognised all at once. Only $100 can be recognised as revenue upon completing each billing cycle. Only $100 can be recorded as revenue in the first month of the contract, whereas the remaining $1100 will be recorded as a liability.

If a customer cancels the subscription soon after the two months of the subscription, you cannot record the subscription charges of the remaining 10 months as revenue.

For this purpose, customer retention rate and solid building relationships are paramount to SaaS business’s success.

  1. Upselling

Depending on the nature of your product, you can upsell to your existing customer by offering them more value. This strategy allows you to earn more revenue from an existing customer.

One of the most significant benefits of upselling is it increases an overall customer lifetime value (CLV). Eventually, the value of your business goes up exponentially if you decide to diversify your equity.

It is worth mentioning here that upselling demands more frequent updates, bug-fixings, and continuous integration of new features to remain competitive. So you still have to put a little bit of extra effort to ensure your additional service is worth paying extra money.

  1. Customer Support

Developing a robust customer support service and charging your customers for that is a great way to add another revenue stream to your SaaS business model. You can include additional charges for customer support or provide it as a separate service to your customers.

Excellent customer support is an effective customer retention strategy that increases the customer retention rate and increases the worth of your business.

  1. Affiliate Revenue

Another great way to generate leads and sales for your SaaS business is an affiliate program. Your affiliates can act as your sales team by harnessing the correct affiliate marketing tools.

Before buying any SaaS business, make sure to analyse its business model. Check out how effective is the revenue model of SaaS business. These metrics assist in determining the commercial viability of the SaaS business.

Key Metrics for Due Diligence While Acquiring a SaaS Business

Pricing Model

The most prominent SaaS growth metric you must understand while buying a SaaS business is its pricing model. Before purchasing any SaaS product, customers first look at its pricing plan and payment options. 

Apart from that, you should consider whether your targeted customer prefers a monthly or annual subscription plan. For most customers, a monthly subscription plan is a viable option as it demands relatively more minor upfront investment and no long-term commitment.

Another factor to consider while evaluating the pricing model of a SaaS business is whether the company has flat fees or fluctuating charges.

Monthly Recurring Revenue (MRR)

Monthly recurring revenue is a company’s average revenue through different pricing plans. With a single and consistent MRR number, savvy investors can determine whether the SaaS Company has steady revenue.

Annualized Recurring Revenue (ARR)

Annual recurring revenue is a yearly revenue a SaaS Company earns within one year. Even though most SaaS businesses generate their revenue from monthly contracts, some SaaS businesses still rely on annual contracts.

Thus, we can say ARR is a straightforward and quick metric to evaluate the financial health of a SaaS Company.

Customer Churn

The subscription-based model is an ultimate source of revenue for almost all SaaS Companies. For this purpose, growth doesn’t only happen when the business expands its customer base but also when it retains its existing customer. That is why the churn rate is a typical metric to focus on.

From the finance standpoint, churn rate indicates what percentages of your total customers leave the platform in a period under consideration.

Revenue Churn

Revenue churn quantifies how much SaaS Company’s bottom line is affected due to the customers cancelling the subscription program.

MRR Growth Rate

MRR growth rate indicates how much revenue is earned or lost due to customer churn. MRR is an insanely effective metric to track any noticeable change in a company’s net income.

Cost of Goods Sold (COGS)

 The cost of goods sold is the total cost incurred in delivering the SaaS product to the end consumer. from the business standpoint, It includes:

  • Installation and configuration cost
  • Customer support cost
  • Hosting cost
  • License fees of all the software integrated into the SaaS product
  • Cost for training company employees

Evaluation of the COGS is imperative to keep the business afloat.

Gross Margin

To calculate gross margin, all you need to do is subtract the cost of goods sold from the company’s net revenue. The accounting perspective is the amount of free cash available to the business to finance its operating expense and investment activities.

Furthermore, it is a strong indicator of the SaaS Company’s scalability. That’s why savvy investors use this metric to evaluate SaaS business.

Some Key SaaS Marketing Metrics

Marketing-specific SaaS metrics are insanely helpful to you, mainly if the SaaS business marketing efforts show results. They are also influential in determining how much growth can the SaaS business achieve in the foreseeable future? 

However, tracking all the SaaS marketing metrics can be overwhelming for savvy investors. Here are some key metrics you should focus on during the due diligence while buying a SaaS business.

Website Traffic

While evaluating the marketing strategies of a SaaS business, one of the crucial metrics to focus on is the total number of visitors visiting the SaaS website. You should consider the total number of unique website visitors each month. 

The more significant number of unique website visitors indicate your content is capturing the traction of your targeted audience and customers. Some well-known examples are:

  • Organic traffic
  • Paid traffic
  • Social media traffic
  • Website traffic
  • Affiliate referrals

Focus more on those marketing techniques that can bring leads and traffic to your website.

Email Subscribers

Email subscribers are the peoples who are included in your mailing list just because they have signed up for that. It is probably the most effective and valuable marketing technique. An extensive mail list shows people are showing their interest in your product.

Additionally, it indicates how engaged your customers are with your SaaS product. Your email list is also a great tool to glimpse a geographical diversification of your subscriber base. Thus, you can effectively make changes in your SaaS product because you have complete data of your customers and their preferences.

Leads

Leads are those visitors that are likely to convert into paying customers. 

SaaS Customer Success Metric

The customer acquisition shows that SaaS Company is expanding its customer base, which is a good indicator. However, the devil lies in the detail. When the SaaS business starts capturing market share, you should emphasise customer success rather than customer acquisition.

Here are some crucial customer success metrics to realise whether the SaaS business you are purchasing is doing well in this area.

Daily Active Users (DAU)

Daily active users show how many users log in to your software regularly. The best way to track DAU is to specify who qualifies for daily active users. From the SaaS perspective, DAU is the quantitative measure of users who log in to your platform daily.

Monthly Active Users (MAU)

Like DAU, MAU shows how many users log in to your platform to use your service in any given month. Both DAU and MAU are vital metrics to evaluate customer engagement with the product. The greater the DAU/MAU ratio is, the more satisfied your customers are with your product. Thus, the probability of having a high retention rate becomes higher.

Net Promoter Score (NPS)

The Net Promoter Score is a metric to evaluate customer satisfaction. To determine NPS, users are being asked the question, “Are you going to recommend this SaaS product to your friends or colleagues?” Respondents of the survey are allowed to choose a score on the scale ranging from 0 (very unlikely) to 10 (very likely).

Conclusion

Performing due diligence while buying a SaaS business is a daunting task. You might have seen many SaaS solutions that sound appealing to you, but they have some shortcomings. I sincerely hope this article will help you in due diligence while buying a SaaS business.

While doing due diligence, do not just reject a SaaS business if it doesn’t fulfil a particular metric. Sometimes a struggling company needs a savvy investor to pour money into business up-gradation and expansion.

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