This article provides the context and more insightful background information around metrics for public SaaS companies in Q2 2021. The research critically reflects and explains the developments of the performances of these companies. Knight Capital has utilized public sources (*) in order to establish its analysis of SaaS companies listed on the NYSE and NASDAQ. This article is provided for information purposes only and does not constitute or form part of any recommendation to buy or sell stocks, nor is it purport to be all-inclusive. Conclusions are drawn from an overall sample of 93 SaaS companies where possible and narrowed down to a more specified sample in case of lacked data. The information contained in this article has not been independently verified and certain of the sample data has been obtained from published sources and/or prepared by third parties. While such sources are believed to be reliable, Knight Capital does not assume any responsibility for the accuracy of the information.
(*) - Our proprietary database consists of data from several public SaaS resources such as the SaaS Capital Index, the Bessemer Venture Partners Index, and Meritech Capital comparables
In this report, we have tracked the performance and valuation multiples of 93 stock-listed SaaS companies in Q2-2021. We have come up with a few findings:
The median valuation multiple for this sample in the respective period amounts to 18.2X ARR, an incline of 9.8% compared to Q1-2021. In Q2-2021 investors started regaining confidence which resulted in rising valuations across the board after higher risk aversion in Q1-2021 as a result of uncertain economic climate related to inflation and Covid-19.
Growth rates came back as the performance metric with the highest correlation to valuation in Q2-2021, after being surpassed by NRR in Q1-2021 as our most relevant determinator of valuation multiples.
Other performance metrics such as the Rule of 40 and NRR have gradually inclined across our sample in Q2-2021. We have identified, though, that the best-performing SaaS companies have disproportionally improved their metrics, widening the performance gap with the remaining researched companies. The best-performing 33% got rewarded for this by achieving an inclining median valuation multiple of 13.2%, versus 9% and 11.6% for the middle- and least 33% performing SaaS companies respectively.
Lastly, we have observed a contradiction where newly IPO-ed companies trade against a 56% premium on valuation while underperforming on several metrics. This could signify that these companies have other valuation determinants or some degree of over-excitement and confidence among investors about newly traded companies.
The Valuation of SaaS Companies in Q2 2021
In April 2021, we concluded that revenue multiples across our sample of SaaS companies had risen as much as 3.4% over Q1-2021, though still outperformed by the S&P 500. Since Q1-2021, it can be said that across-the-board revenue multiples have risen substantially again. As the median revenue multiple for our SaaS sample equaled 16.6x in March 2021, the median end of period revenue multiple in Q2-2021 approximates 18.2x, a rise of approximately 9.8%. In line with this, 58% of the researched SaaS companies have experienced growing valuation multiples since March 2021. Interestingly, 13 SaaS companies (14%) are identified with a revenue multiple higher than 40X, whereas in March 2021 this was ‘only’ 7 (9%). Moreover, 92% of these companies in Q2-2021 experienced growing revenue multiples since March 2021 (including Asana with a staggering growth of 77%), compared to 29% of the higher valued SaaS companies in Q1-2021.
This demonstrates the decreased risk aversion amongst investors, further shown by the outperformance of the S&P 500 in growth rate in Q2-2021 (+8.6% QoQ). The comeback of SaaS resembles the ongoing excitement among investors in SaaS, despite some earlier concerns about the reliance of some software companies on remote working and some lifted measures around Covid-19 in parts of the western world. Another potential reason is the -better than expected- Q1 performance of SaaS.
Although the quarterly growth rate is considerable, it should be noted that there was also the underlying volatility in revenue multiples throughout the quarter. After a climb in valuations to 17.5X ARR in April 2021, the median revenue multiple dropped 5% to 16.6X ARR in May 2021. Hence, SaaS multiples have caught up in June 2021 again to the prementioned median revenue multiple of 18.2x. The average revenue multiple in June 2021 across our SaaS sample equals 22.7x (+10.3% QoQ).
In our research from Q1-2021, we identified a shift from growth rate to net dollar retention rate as the most significant determinant of the revenue multiple (the respective correlation coefficients amounted to 0.43 and 0.64). In our analysis, we related this shift to the reaction of financial markets to an uncertain investing climate. As we have observed decreased risk aversion in Q2-2021, it is striking to see that growth rates have taken back the lead as the most significant contributor to revenue multiples. The correlation coefficient of this performance metric has bounced back to historical levels of 0.61 in Q2-2021 (Q1-2021: 0.43), whilst NRR has dropped to 0.50 (Q1-2021: 0.64). This demonstrates that our initial hypothesis still holds.
Another driver of valuation (with a lower, yet positive impact) is the founding year with a correlation of 0.39 (equal to Q1-2021). It is observed that younger SaaS companies enjoy higher valuation multiples, possibly triggered by higher average growth rates and the role of the challenger rather than the incumbent.
Appendix 1 shows the revenue multiple of all 93 researched SaaS companies.
Figure 1: Median Revenue Multiple Categorized by Founding Year. Younger SaaS Companies are Often Favored and Rewarded by Investors.
Gross Margins and Financial Viability
Another selection of 71 SaaS companies shows median gross margins in a similar range (76%) to Q4-2020 and Q1-2021. When it comes to the median Rule of 40 score, a slight increase from 39% in Q1-2021 to 42% in Q2-2021 has been observed. Interestingly, 63% of the SaaS sample has managed to increase their Rule of 40 score over Q2-2021, with an average improvement of 12%.
The modest incline is therefore primarily driven by newly listed SaaS companies with a lower Rule of 40 scores. Over Q2-2021, 11 new companies are added to our sample which has recently gone public: Alkami, C3.ai, Confluent, DigitalOcean, Intapp, KnowBe4, Olo, Procore, SentinelOne, Sprinklr, Squarespace, and UiPath. Indeed, the median Rule of 40 scores of these companies is 30% only, meaning below par. The most notable new entrants with a lower Rule of 40 scores are C3.ai (-4%), Sprinklr (10%), and Intapp (23%). The median revenue multiple of this group of companies is, however, 28.6X which implies a 57% premium (!) compared to the overall SaaS sample. This premium cannot be explained by other performance metrics such as growth rates and net retention rates, which are at a fairly similar level to the overall SaaS sample.
A similar conclusion can be drawn on free cash flow margins, which are on average negative for the new entrants (-7% vs. 6% on average for the overall SaaS sample, and -1% vs. 9% on a median basis). The newly researched SaaS companies with the lowest free cash flow margins are SentinelOne (-79%), Confluent (-28%), and C3.ai (-21%). Again, these companies are still rewarded by the market with an average revenue multiple of 54.6X.
The Rule of 40 breakdown for each investigated SaaS company has been displayed in Appendix 2.
Figure 2: Newly Added SaaS Companies Median Performance Benchmarked Against Overall Sample
Underlying Customer Profiles
As usual, we plot the (61) SaaS businesses in Christoph Janz’s model of customer segments.
Figure 3: The Animal Analogy Applied to our Sample of SaaS Companies
Compared to our report of Q1-2021, the SaaS sample has become bigger and so has the composition of the clusters in figure 3. From the newly added SaaS businesses, 75% focuses on Elephants which seems to showcase the increasing attractiveness of (big) Enterprise targeting companies. Where our previous research demonstrated the gradual decline of payback periods per customer class, this no longer applies for Q2-2021. The 16 companies targeting Rabbits enjoy smaller median payback periods than the 3 companies targeting Flies. Out of our sample of 61 SaaS companies, 28 companies deploy a Freemium model. From these 28 companies, 19 companies are hunting for Flies and Rabbits which confirms the general thought that this sales strategy is more effective for lower-touch acquisition models.
Figure 4: Overview of Performance Metrics per Sales Category
In figure 4, the performance metrics per customer class have been showcased and benchmarked against the same metrics for Q1-2021. Although the ‘ranking’ among the classes has changed, some consistency in the performance of classes is noticed. Companies hunting Flies still have the highest median ARR, while Rabbit hunters experience the highest median YoY growth rates and gross margins. Regarding net retention rate, some changes are observable though. The median NRR for Deer hunters has risen and now exceeds the same metric for companies targeting Elephants now. This is partially due to the listings of new Deer-targeting companies such as UiPath and SentinelOne.
This quarter we have looked at additional metrics such as the Free Cashflow Margin per animal class, and the median percentage of the companies’ revenues spent on sales & marketing (S&M) expenses. Both metrics show (to a large extent) that companies targeting smaller types of customers experience less cash burn. Nevertheless, it is also remarkable that despite the harder efforts for Enterprise focused companies to sell a product (illustrated by often longer sales cycles and payback periods), the S&M expenses as a percentage of revenues are similar to companies focusing on smaller customers. This may resemble the fact that higher NRR and longer customer lifetimes generally offset the enhanced sales efforts.
As we showed before, the net dollar retention rate has become less relevant in determining the valuation multiple of our sample of SaaS companies. The median net dollar retention rate from our SaaS sample of 59 companies has increased to 117% in Q2-2021 from 115% in Q1-2021. This equals the median net dollar retention rate of the newly adopted SaaS companies in our sample. The average net dollar retention rate of the new companies does exceed the overall SaaS sample’s average, however (120% vs. 116%). This is primarily driven by an outlier such as UiPath, with a stunning NRR of 153%. With this NRR, UiPath ranks as the third-highest company after Snowflake (168%) and nCino (155%).
Figure 5: Net Dollar Retention Rate vs. Revenue Multiple for 59 SaaS Companies.
Light Green Companies are Newly Added this Period
Figure 6: Benchmark Analysis Performance Metrics Q2 2021
In Figure 6 the performance results across 3 classes of SaaS companies are depicted and benchmarked against the performance of the classes in the previous quarter. It becomes clear that the deviation between ‘good’ and ‘bad’ performing companies is getting bigger (showcased by increased deviations in growth numbers, gross margins, payback periods, and cashflow margins). This might explain our finding of high(er) valued SaaS companies were getting more popular under investors in Q2-2021.
Nevertheless, we also observe that the 33% best in class SaaS companies do still not always meet all criteria of a great SaaS company. Figure 7 illustrates this, where the percentage of SaaS companies are calculated of which indeed meets the prementioned benchmarks for the respective performance indicator. It turns out that for companies it is the most challenging to become a Cash(flow) Cow and meet the 25% Cashflow Margin benchmark.