Valuating B2B SaaS

Contextualization

B2B (Business-to-Business) SaaS (Software as a Service) is one of the most prevalent business models in the tech industry. Its scalability, recurring revenue model, and potential for high growth make many B2B SaaS businesses viable acquisition targets.

B2B SaaS companies typically fall into two categories: horizontal and vertical. Horizontal SaaS involves generalist products that address widespread needs—think Salesforce or Shopify. Vertical SaaS, on the other hand, focuses on niche markets, offering specialized solutions tailored to specific industries. Examples include Guidewire for the insurance sector. While horizontal SaaS models have dominated historically, vertical SaaS is an emerging trend with growing investor interest.

Pillars Of Investments

Let’s break down the B2B SaaS market into five pillars: Clientele, Product, Market Dynamics, Business Operations, and The Team.

Clientele

Understanding the customer base is paramount to evaluating any investment. These metrics allow you to understand customer value, lifecycle, and inflow/outflow for B2B SaaS specifically:

• Client Acquisition Cost (CAC): cost to acquire a customer. A low CAC relative to revenue per customer is good.

• Attrition Rate & Retention Rate: Indicate how effectively the company gains/loses customers. The better the net retention (retention - attrition), the better the recurring revenue.

• Average Contract Value (ACV): Self-explanatory. We want high value contracts.

• Customer Lifetime Value (CLV): ACV x Customer Lifetime. Quantifies the revenue for each customer over their lifetime.

• Customer Concentration: Determines clientele fragmentation. We don’t want to be dependent on just a few key clients.

• Net Promoter Score (NPS): Quantifies customer loyalty. A high NPS indicates strong customer satisfaction and brand value.

• Renewal Rate: another important metric for determining recurring revenue

• Net Revenue Retention (GRR) & Gross Revenue Retention (GRR): measure how well the company retains revenue from its existing customer base

Product

This pillar focuses on product viability. Key factors include:

• Differentiation: How does the product stand out in a potentially saturated market? It needs to be “special” to have customer appeal.

• Scalability: How easily does the product’s structure adapt to scale? Cloud-based solutions do well in this regard due to their low unit costs.

• Sustainability: Maintenance ad upkeep costs should be low enough to avoid compromising margins. We don’t want to dump a large amount of cashflow back into R&D just to remain viable. Self-sufficiency is a plus.

• Integrations: Synergies with major platforms like AWS, Salesforce, or OpenAI bolsters the product’s appeal, stickiness, and image.

• % of Revenue from Software: SaaS companies should primarily generate revenue from subscriptions. Reliance on services or consulting could signal a weak SaaS model.

• Pricing Strategy: The choice of pricing model—tiered, per-seat, usage-based, or enterprise licensing— fully influences revenue predictability and client capture. Price elasticity must also be studied to avoid over- or underpricing the product.

Note: SaaS companies sometimes rely on product-led growth (PLG) strategies, such as freemium models, to lower CAC and drive adoption. Evaluating the efficacy of implementing these alternative strategies is crucial during diligence.

Market Dynamics

Like any business, market dynamics are incredibly important. Key considerations include:

• Total Addressable Market (TAM): how much room is there to grow?

• Market Share & Capture Potential: How much of the market does the company currently hold, and how much can it realistically expand into?

• Entry Barriers: Entry barriers protect against new upstarts. These can look like anything from regulatory hurdles, vertical infrastructure, technical complexity, or proprietary technologies.

• Fragmentation: Fragmented markets with multiple players are ideal, offering opportunities for consolidation and easier market capture. We don’t want to try to overtake a monopoly.

• High Switching Costs: Products that are difficult (financially or in relation to time) to migrate away from ensure higher retention and recurring revenue. This may backfire though, as it may cause potential new clients to be wary of adopting the technology.

• Maturity: Mature markets offer stability. We don’t want to be in a new, untested one.

• Regulation: SaaS companies in data-sensitive sectors must navigate compliance challenges, such as GDPR or HIPAA.

• Inelastic Demand: Products addressing critical pain points are less vulnerable to economic downturns.

High switching costs and integrations with major platforms not only enhance retention but also create competitive advantages by locking customers into the ecosystem.

Business Operations

We need to evaluate the financial and operational health of the company too. Key factors include:

• Gross Margin: SaaS companies typically have high gross margins, often exceeding 70%-80%. This is essential for scalability, as it allows for cashflow to trickle down to growth areas like R&D and sales.

• Operational Leverage: SaaS companies benefit from high fixed costs relative to low variable costs. As the company scales, profitability increases disproportionately due to fixed cost absorption.

• Low Unit Cost: A low variable cost per customer ensures the company can scale effectively.

• Revenue Growth Rate: High growth is essential, especially given the premium multiples typically paid for SaaS businesses. It demonstrates the company’s ability to scale and capture market share. It can also be an investments downfall if the company does not meet projections.

• LTV/CAC Ratio: Evaluates a customer's value over their acquiring cost. A ratio above 3x is considered strong.

• Debt Levels: SaaS companies often operate with minimal cash flow margins caused by heavy reinvestment in growth and R&D. High debt levels are a red flag, as they could strain the business before it reaches profitability.

• Founder Dependency: If the company is overly reliant on its founding member(s), it can pose a risk, especially in majority buyouts. The leadership team should be self-sufficient.

• Capital Efficiency: We don’t want to grow with excessive cash burn or over-leveraging.

• Benchmarking: Comparing key performance indicators (KPIs)—such as CAC, churn, and gross margins—to industry standards provides good context for assessing viability.

• Burn Rate vs. Runway: Help evaluate how long the company can operate before requiring more funding. Companies with a long runway or low burn rate are better set to hit profitability milestones.

The Team

The leadership team makes or breaks typically lean tech companies:

• Expertise & Vision: Founders with deep industry knowledge or prior successful exits.

• Adaptability: A team that can navigate market disruptions or economic downturns.

• Roadmap to Profitability: A clear plan to achieve profitability is essential, especially in high-growth SaaS companies with slim margins.

• Go-to-Market Strategy (GTM): Sales efficiency metrics like the “magic number” (ARR growth / sales & marketing spend) provide insight into the strategy’s effectiveness.

Trends

Regulation & Governance

Governance is a major consideration for B2B SaaS companies, particularly in industries with sensitive data like healthcare. Regulations such as GDPR, HIPAA, and industry-specific standards can restrict how companies can scale, handle integrations, or conduct client outreach.

Failure to comply with these requirements can lead to litigation, reputational damage, and/or a loss of clients. For example, a Business Intelligence (BI) SaaS provider in healthcare must have a comprehensive data security protocol. Any security breach in this space could result in large fines or lawsuits, hindering growth and negatively impacting investor returns.

A company must be able to adapt to these frameworks while factoring in the cost of compliance.

Market Attention

B2B SaaS has become one of the largest and fastest-growing business models, attracting significant capital and market attention. This is great for founders seeking funding, but it creates challenges for investors:

• Valuation Multiples: The sector commands extremely high entry multiples, with companies valuated at 10x–15x (up to 50x for Figma) of ARR, even when operating with low cash margins (low support for leverage).

• Competitive Bidding: Funds recently have been outbidding each other for promising targets, further inflating valuations and reducing IRR.

This makes due diligence paramount. You don’t want to overpay for a company with aggressive growth projections or unrealistic targets: you’ll tank your IRR, especially if it doesn’t meet projections.

Technology Advancement

The SaaS landscape is highly susceptible to advancements in technology. Just recently, the emergence of Generative AI (GenAI) has shaken things up:

• Risks: Companies that fail to adapt product offerings or integrate with upstart technologies risk being displaced by innovative competitors.

• Opportunities: SaaS companies that successfully incorporate new innovations into their platforms can gain significant competitive advantages, such as enhanced personalization, automation, and analytics capabilities.

Investors should evaluate whether a target company’s product is future-proof or adaptable to new technological innovation. This would likely hinge on leadership’s expertise in innovation and the company’s ability to pivot as needed.

Trending Markets

Certain SaaS markets stand out as particularly lucrative due to their structure:

• ERP (Enterprise Resource Planning): Necessary for streamlining operations, ERP systems are entrenched in company operations, creating high switching costs and strong recurring revenue streams.

• CRM (Customer Relationship Management): CRMs like Salesforce are irreplaceable tools for sales and marketing teams, ensuring inelastic demand and strong market penetration.

• Regulatory Compliance: SaaS solutions designed for compliance address non-negotiable pain points, offering reliable demand and stable cash flows.

These markets exhibit fragmentation, with numerous niche players operating alongside dominant leaders. This dynamic creates opportunities for targeted investments or roll-up strategies.

Alternatives

The stage of a SaaS company determines the type of capital it attracts:

• Venture Capital: Early-stage funding (e.g., Series A or B) with high growth potential, focusing more on qualitative factors like product innovation and market fit. Profitability is not typically a requirement.

• Growth Equity: Looks for companies nearing profitability with established business models and aggressive growth trajectory. Often valued between $20M and $200M.

• Private Equity: Larger, more stable companies with predictable cash flows that can support leverage. These firms are usually valued above $200M but may sacrifice growth for stability.

Each investment strategy offers unique opportunities and risks, and investors must align their diligence and expectations with the company's stage of development.

The Bottom Line

The SaaS industry is both an attractive and challenging space for investors. While its scalability, recurring revenue, and high growth potential (14% CAGR) make it quite appealing, market saturation, inflated valuations, and rapid innovation require careful diligence.

By focusing on the 5 pillars, investors can identify promising opportunities effectively while avoiding common pitfalls. For venture capital and growth equity players especially, SaaS offers strong upside, particularly in minority deals where experienced founders retain operational control. With the right strategy, SaaS investments can deliver strong returns while supporting the continued evolution of this dynamic sector.