The software industry model getting the most attention today is without doubt Software as a Service (SaaS). Lets examine some of the underlying features of SaaS that make it a winner for both users and ISVs and, as a result, make it attractive for investors and acquirers.
SaaS is a model that involves the delivery of software solutions in a form different from the traditional, on-premise client-server solution that has dominated enterprise computing. With SaaS, a third-party hosts the application and end users access applications over the web. With high speed secure networks, end users enjoy high performance and reliability while outsourcing the management of hardware, networks, application updates, backups, database administration, etc. The net result to end-user organizations is lower cost and easier deployments. The hosting organization (ISV or a third party) can offer these services more efficiently with economies of scale. The ISV reduces support costs as the applications are running on servers under their control, without multiple hardware and software versions that must be supported and maintained with the on-premise model.
SaaS can be priced many ways, but is typically identified with a subscription model, monthly fees per user, and no initial license fee. This minimizes the customers capital commitment and can shorten the sales cycle, an attractive feature for any ISV. Lower up front costs may allow the ISV to establish a foothold at a department level, and later expand more broadly in an enterprise. There is still a need for implementation services, data conversion, and training that drives further revenue.
So, what do investors think of a model that is high in recurring revenue, and highly profitable at scale? The best example of this is Salesforce.com, the industry poster child trading at 10x+ trailing revenues, three or four times the valuation of traditional public CRM/ERP companies. From an M&A viewpoint we are just beginning to see transactions involving pure play SaaS companies. With only limited data from 30 recent transactions, deals were valued from 3.75 to 7.0 times revenue. This reflects a significant premium for SaaS companies compared to traditional vertical market solutions where transaction values are often in the 1.75 to 2.25x revenue range.
A version of this article originally appeared in Soft•letter and Software Success.