How to value SaaS companies? A Guide for Investors

Earlier, we shared that Software-as-a-service (Saas) is changing the way businesses and individuals use software. 

Instead of buying software as a one-time purchase and installing it on a single device, SaaS allows users to access applications through the internet on a subscription basis. 

This means greater convenience, flexibility, and often lower costs for users compared to traditional software.

In this guide, we will share the key metrics when evaluating SaaS companies, as well as the valuation metrics to identify opportunities in SaaS stocks. 

Key metrics to evaluate SaaS companies

SaaS companies operate differently from traditional software providers. Instead of one-time software sales, they use a subscription-based model, which generates recurring revenue. 

SaaS companies generate revenue through different pricing strategies, including:

• Subscription-based: Customers pay monthly or annually, ensuring a steady revenue stream for the company.

• Freemium: Basic features are free, with premium features requiring payment (e.g., Zoom’s free basic plan with paid upgrades.
• Usage-based: Fees are charged based on actual usage, such as cloud storage or API calls (e.g., Twilio and Snowflake

Annual Recurring Revenue (ARR)

Annual Recurring Revenue (ARR) measures the predictable revenue a SaaS company earns from subscriptions over a year. 

ARR is calculated by adding total revenue of yearly subscriptions with the total revenue from add-ons and upgrades, less the total revenue due to downgrades, cancellations and churn. 

It offers a clear and reliable projections of a SaaS company’s future revenue, assuming consistent customer retention and steady sales growth.

Companies grow ARR by acquiring new customers, upselling existing customers, or expanding their product of offerings

Recurring Revenue Mix 

Recurring Revenue Mix, an extension of the Annual Recurring Revenue (ARR) concept, is the percentage of revenues that are subscription-based, out of a SaaS company’s total revenue.

The higher the recurring revenue mix, the larger the amount of consistent and predictable revenue stream a company has. 

This may have a compounding effect on revenue, as businesses are able to benefit from sustained engagement and value delivery through the customer life cycle. 

For publicly listed SaaS companies, recurring revenue mix range from 66% to 89%, with the average public SaaS company having an average of 80% recurring revenue mix, according to analysis from Shea & Company.

Retention Rate

Retention rate measures how well a SaaS company keeps its customers over time. Retention rate serves as a crucial metric for evaluating customer satisfaction, service quality, and the long-term health of the business. 

There are two main types:

• Gross Retention Rate: Measures the ability to retain existing customers, and measured by the current period ARR, less the downgrade ARR (decrease in revenue caused by existing customers) and less the Churn ARR (revenue lost due to customer cancellations).

• Net Retention Rate: Measures the ability to expand with existing customers, and measured by the current period ARR, less the downgrade ARR, less the Churn ARR and with the addition of LTM net expansion (expansion revenue from upsells, cross-sells, and add-ons from current customers). 

The benchmark dollar-based gross retention rate for Enterprise-focused SaaS companies is 87%, while the benchmark for Small and Medium Businesses (SMB)-focused SaaS companies is 72%, according to analysis from Shea and Company. 

Lifetime Value (LTV) vs Customer Acquisition Cost (CAC)

• LTV: Estimates the total revenue a company can earn from a customer over their lifetime.

• CAC: Measures how much a company spends to acquire a new customer.

• A strong SaaS business typically maintains an LTV to CAC ratio of at least 3:1, meaning the revenue earned from a customer should be at least three times the cost of acquiring them.

Valuing SaaS Companies

The “Rule of 40” is a critical metric in assessing SaaS companies, where the sum of a company’s revenue growth rate and profit margin should exceed 40%.  

The Rule of 40 is widely recognised as a metric for evaluating growth, with companies that have exceeded 40% on this metric demonstrating strong growth potential. 

Companies exceeding this threshold are generally viewed as financially healthy and tend to trade at higher valuations.

Data suggests a strong relationship between the rule of 40 with stock prices. As of January 2025,, SaaS companies which have exceeded the Rule of 40 trade at an average Enterprise Value-to-Revenue (EV/Sales) ratio of 11x, compared to companies whose sum of revenue growth rate and profit margin are between 30% to 40%.

Beyond standard financials, SaaS-specific KPIs like ARR growth and retention rates are essential for evaluating a company’s long-term success.

Traditional valuation metrics like price-to-earnings (P/E) ratios are less relevant for SaaS companies, many of which operate at little or no profit. Instead, the Enterprise Value-to-Revenue (EV/Sales) ratio is widely used. This measures how many times annual revenue a company is worth. 

Historically, SaaS companies have traded at higher EV/Sales multiples compared to the broader market due to their recurring revenue and strong growth potential. 

During the 2020–2021 tech boom, public SaaS companies saw valuations soar, with median EV/Sales multiples reaching 15–18x, and some exceeding 30–50x revenue. However, rising interest rates in 2023 brought these multiples down.

Learn more about the SaaS industry with our interview with Chief Strategy Officer of Avepoint

If you are keen to find out more about SaaS and key factors to look out for when evaluating SaaS companies, we recently spoke to Mario Carvajal, AvePoint's Chief Strategy & Marketing Officer. 

As AvePoint’s Chief Strategy & Marketing Officer, Mario is responsible for all aspects of the AvePoint brand and marketing approach for customers, partners and investors, while maintaining responsibility for developing the Company’s growth strategy and initiatives such as corporate development, strategic planning, mergers and acquisitions, and strategic partnerships. 

Watch the recorded interview below. 

Learn more about the SaaS industry by downloading our guide for investors here. 

Join the Beansprout Telegram group for the latest insights on Singapore stocks, REITs, bonds and ETFs. 

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