A fast growing market
Research shows that the SaaS market is expected to reach $436.9 billion in 2025, up from $225.6 billion in 2020.
Now that’s a fast growing market!
As a savvy entrepreneur, that’s probably why you want in on the multi-billion dollar pie. I mean who wouldn’t want the financial freedom that comes with it?
But how do you complete all due diligence when buying a SaaS business?
This guide on how to complete due diligence when buying a Saas business will walk you through how you can do just that.
- The SaaS market is expected to reach $436.9 billion in 2025.
- The unique number of SaaS apps in usage per company was up by about 30% year over year.
- The SaaS expenditure per company has increased to 50% in 2020.
- 73% of organizations indicated that nearly all their apps will be SaaS in 2021.
What is a SaaS company?
The fourth industrial revolution (4IR) has changed the way businesses run. The advent and growth of cloud-based infrastructures have fast-tracked digital transformation across the globe. And that has led to the birth and fast-paced growth of software-as-a-Service (SaaS) business models.
Simply put, a SaaS company is an organization that uses software to provide its customers with a service. SaaS companies develop and centrally host a software product and customers are granted access to the product for a fee. This fee is also referred to as a license, seat or subscription, and companies will often offer different subscription plans with varying levels of access, functionality and features. It’s also the SaaS company’s responsibility to update the product, maintain the servers the software is hosted on and ensure compliance with security standards. The types of SaaS business span the gamut from meeting management software to SEO tools and everything in between.
Advantages of the SaaS business model
SaaS is the business model of the future. Among the myriad advantages this business model has, here are a few of the most significant ones:
SaaS businesses are easy to scale and don’t strain your resources as you do so. In fact, as your customer base grows, the overall cost of servicing customers declines.
SaaS subscription models are more accommodating to the needs of the customer than one-off payment models. They also offer adaptability that on-site solutions can’t provide. Additionally, SaaS offers flexible monthly and yearly timeframes for subscriptions that can be paid on an as-needed basis as there’s no need to purchase a license to host the software on-site.
This is due to the inherent high barrier to exit or canceling a subscription (and switching costs) for customers who rely on (and love) your SaaS product.
High buyout potential
Thanks to a proven business model, selling your SaaS business at a profit is easier than selling a product-based business. This is especially true if users love and use your product regularly.
Lower maintenance and management costs
A SaaS product comes with cost and time efficiencies when deploying updates and new features when compared to on-premise software. With on-premise software, you have to consider many other factors such as more work hours needed for your IT department to work onsite to update your customers system. In terms of cost, most SaaS applications can be deployed and put into use much faster and for a fraction of the cost in comparison to traditional software solutions. You’ll also save on on-going maintenance infrastructure costs.
If you’re looking to acquire a SaaS company, you need to conduct a rigorous due diligence process that uncovers key business drivers. This helps you make data-driven decisions that result in you buying a profitable SaaS business.
Buying a SaaS business vs. starting a SaaS business
When it comes to owning a SaaS business, you have two options—buying one or starting one.
Which route should you take?
There are several factors to consider as you ponder this question. However, in most cases, as an investor, buying a SaaS business is a compelling path to consider. Here are a few reasons why:
Buying a SaaS business saves you years of time you’d otherwise spend on market research, product development, and marketing.
Also, time to market is crucial when launching any product. It’s an essential ingredient to maintaining a competitive edge. With SaaS products, time to market is greatly reduced as the entire product development is done online. Users access the MVP online in a matter of seconds and feedback can also be gathered quickly. As a result, better iterations of the product can be released faster.
A lot of money goes into the research and development (R&D) and the product development stages of building a SaaS product from the ground up. Buying a SaaS business saves you from pouring money into a SaaS product you’re not 100% sure of.
You don’t need coding skills
Starting a SaaS business from scratch requires that you be adept at coding. Buying one doesn’t. Sure, you can hire the best developers on the planet and they can help you turn your idea into a profitable software service. But that route requires a huge investment of time and money.
Examples of successful SaaS companies
A lot of money goes into the research and development (R&D) and the product development stages of building a SaaS product from the ground up. Buying a SaaS business saves you from pouring money into a SaaS product you’re not 100% sure of.
BigCommerce is a SaaS product that allows entrepreneurs to set up and run e-commerce shops even without any coding experience.
Slack has become synonymous with remote work. It’s a platform that enables remote teams to collaborate on projects.
Zoom is a cloud-based video communications platform that allows users to set up virtual video and audio conferencing, webinars, live chats, and much more.
PandaDoc enables you to design, create, approve, track, and e-sign documents online.
Is an online survey developer tool that helps users create personalized surveys, quizzes, and assessments. It also automatically generates reports that feature personalized advice.
Salesforce provides customer relationship management (CRM) solutions. It also offers a complementary suite of enterprise applications that span the gamut from marketing automation to application development.
As you can see from the above examples, you can run a SaaS business in virtually any industry and market. So, time for some due diligence so you buy yourself a profitable SaaS business.
What to consider when buying a SaaS company
It’s no secret that tech companies are where the money is. With every industry executing digital transformation, the need for software as a service is at an unprecedented high.
However, not all SaaS businesses are profitable. That’s why due diligence is essential when considering buying a software company. Here are few tips on doing just that:
The overall business model
One of the first steps to completing due diligence when buying a SaaS business is to understand the overall business model. SaaS businesses are different from other business models in that your customers don’t actually get to buy your product for a one-time fee. Instead, you have many different ways you can monetize your service delivery. Here are the most common ones:
The subscription model is the primary model for revenue generation for most SaaS businesses. It involves charging your customers a monthly or annual subscription fee for using your software. Here’s Hubspot’s example:
Note however, that the revenue recognition in SaaS is different from the one-time payments other business models run on. With a SaaS business revenue is recognized on a monthly recurring revenue (MRR) model. In this model, even if the customer paid in advance for a subscription, the revenue cannot be recognized until the month’s service is “consumed” and hence earned by the SaaS company.
Let’s look at a typical example of this:
If a customer signs up for a year at $10 a month. The $120 annual revenue can not be recognized all at once. Only $10 per month can be recognized — at the end of the billing cycle. In month one, $10 of revenue can be booked, with $110 booked as a liability. If a customer leaves after two months of a subscription, you cannot recognize the remaining 10 months.
This is why you must put tremendous value and importance on customer retention and building good relationships with your install base of subscribers.
Depending on your product, you can upsell to existing customers by offering more bandwidth, storage, and other extra benefits. This method helps you increase the revenue your business is already earning from the subscription model.
One of the biggest advantages of successful upselling is that it increases customer lifetime value (CLV). This in turn results in long-term profitability per customer and increases the value of your business if you decide to sell it later.
However, upselling to enhanced services also demands more frequent upgrades, bug-fixes and new features to keep your service fresh, up to date and competitive. So you’ll have to put in a bit of work to ensure your enhanced services are worth the extra cost.
3. Customer support
Developing an excellent customer support service and charging for it is another way you can add a revenue stream to your SaaS business model. You can build it into your pricing models at an extra cost or offer it as a standalone service.
Superb customer service is a customer retention strategy that not only keeps your customers loyal, but is an opportunity for word of mouth referrals. It’s also a good driver of higher NPS scores (see below) and helps generate positive reviews.
4. Affiliate revenue
One of the best ways to drive traffic and generate sales for a SaaS business is by running an affiliate program. A well-designed one is an added bonus when you’re looking for a target SaaS business to buy. With the right affiliate marketing tools, your affiliates can easily become your most effective sales team.
As you consider buying a SaaS business, look at the overall business model. Check how effective revenue generation methods and service delivery models are. These are good indicators of whether the business is viable in the long run.
Key SaaS growth metrics
A key SaaS growth metric you must understand when looking to buy a SaaS business is the pricing model. The way a product is priced and the terms of payment are crucial barriers people cross before becoming subscribers. For example, does the target business use a monthly subscription model or an annual one? For most new customers, the monthly model is preferred as there’s less upfront investment required and no long-term commitment. Another consideration to make is whether the business charges a flat fee or runs on a tiered pricing model.
Monthly Recurring Revenue (MRR)
MRR refers to all your recurring revenue normalized into a monthly amount. It provides an easy way to understand the average revenue you generate through your various pricing plans and billing periods. MRR puts them into a single, consistent number that allows you to easily track revenue trends over time.
Annualised Run Rate (ARR)
Annualized Run Rate (also referred to as Annual Recurring Revenue) is the recurring revenue generated by a SaaS business over the course of a year. While some businesses generate their income on monthly subscriptions, other SaaS businesses deal primarily in yearly contracts. This makes ARR an easier and clearer metric to use to gauge the pulse of the business.
Most SaaS businesses are built around the subscription model. Because of this, growth is usually a function of not only acquiring new customers but retaining them as well. This is why the rate at which customers cancel their subscriptions, or customer churn, is a critical metric to track. Churn rate is expressed as a percentage of the number of customers you lost over the total number of customers you had at a given period. SaaS churn rates are lower than most subscription-based businesses, another reason to buy a SaaS business.
Revenue churn is a metric that shows how much MRR is lost as a result of customer churn or customers downgrading their subscriptions.
MRR growth rate
MRR growth rate is the net increase (or decrease) in MRR from one month to the next due to new revenue earned or lost revenue due to churn. Your monthly recurring revenue changes month-on-month because of new revenue earned and lost revenue due to churn. MRR growth rate is an extremely useful metric for measuring the improvement of your revenue generation over time.
Cost of Goods Sold (COGS)
In SaaS, the cost of goods sold (COGS) refers to the total expenditure associated with delivering your SaaS product to your customers. Examples may include:
- Application hosting and monitoring costs
Account management costs
Software license fees for third-party products embedded in the application
- Customer support
- Web development and support costs
- Professional services and personnel training costs
COGS is essential to knowing the expenses required to keep the business running.
Gross margin is the difference between your total revenue and the cost of goods sold. Operationally, it reflects the amount available for a business to pay its operating expenses and reinvest back into the business. It also serves as a good indicator of scalability, making it a critical metric investors look at to determine valuation.
Key SaaS Marketing Metrics
Marketing-specific SaaS metrics are essential in helping you see if the business’s current marketing efforts are bearing fruit. They’re also helpful in gauging the potential growth of the business. However, when it comes to SaaS marketing metrics, they can be so many tracking all of them would be overwhelming.
So which ones must you focus on as you do your due diligence in buying a SaaS business?
When it comes to SaaS marketing, one of the most important metrics to look at is the people who visit your website. You must take particular note of the number of unique website visitors you get in a month. A high number of unique website visitors is a good indicator that your top of funnel content is resonating with your target audience.
Besides the number of unique website visitors, you must also take note of the channels that are bringing in the most traffic. Examples include:
- Organic traffic
- Paid search
- Social media
Focus more effort and resources on the channels that are more effective in driving traffic to your business.
Email subscribers are people who have signed up to be on your mailing list. This is usually through the business’s marketing campaigns. A large email list also shows that there’s a good market for your product. When analyzing the email marketing efforts of the target business, check out for:
- Open rates
- Unsubscribe rates
- Clickthrough rates
These are excellent indicators of how engaged subscribers are. Your email list is also a great way to get a sense of the geographic breakdown of your subscriber base. This gives you insight into important considerations such as language, currency, credit card gateways and new markets to support and build out.
Leads are people who have shown interest in your product in one way or another beyond just giving you their email address. In SaaS, this usually means giving you information such as their name, job title, business name, et cetera.
Marketing Qualified Leads (MQLs)
Marketing qualified leads (MQLs) are leads that fit the required demographics of your ideal customer profile (ICP). More than that, they must demonstrate an interest in your SaaS product. This can be engaging with your product-focused content more.
Sales Qualified Leads (SQLS)
Sales qualified leads (SQLs) are MQLs that have expressed interest in purchasing your product. They show they’re sales-ready by taking actions such as booking a demo or sales call.
Opportunities & paying customers
Opportunities are SQLs that have been vetted and deemed genuine sales opportunities. They’re ready for you to start the sales process. Paying customers are a step ahead and have signed the dotted line and have paid for one of your plans.
While these metrics are more sales-focused, it’s always advisable to track how leads generated by marketing convert into paying customers. This is essential to assess the performance of the business’s marketing strategy.
Key SaaS sales metrics
SaaS sales metrics are one of the most important areas to dig into as you conduct your due diligence in buying a SaaS business. They give you a lot of insight into the business you intend to acquire, particularly the validity of the revenue models and the efficiency of the sales process. Here are the top SaaS sales metrics to keep your finger on
Average Revenue Per Account (ARPA)
Average Revenue Per Account (ARPA), is a SaaS sales metric used to measure the revenue contributed by an account or customer per month/year. It’s sometimes called Average Revenue Per User (ARPU) or Average Revenue Per Customer (ARPC).
ARPA allows you to analyze a company’s revenue generation and growth on a per-unit level. This can help you as an investor to identify which products are high or low revenue-generators.
Average Selling Price (ASP)
Average Selling Price (ASP) measures the average initial MRR of new customers at the point they convert to paying customers. Understanding your ASP is essential to, among other things:
- Determining the right sales model for your SaaS business.
- Forecasting whether your customer lifetime value (LTV) will increase or decrease.
Customer Acquisition Costs (CAC)
As the name suggests, customer acquisition costs (CAC) refer to the amount spent in acquiring a new customer. This usually involves the cost of generating that lead and the cost of converting the lead into a customer. If the CAC is too high, the profitability of the business you intend to buy is doubtful.
Customer Lifetime Value (LTV)
Customer lifetime value (LTV) is a measure of the amount of revenue a single customer is expected to generate over the life of their subscription. In short, LTV shows how much each customer contributes to your bottom line, and estimates for how long. LTV also helps determine how much you must spend on acquiring each customer (CAC). You can also segment LTV by different customer types to hone in on and put more effort in selling to your most valuable buyer personas.
LTV: CAC ratio
As individual metrics, LTV and CAC don’t mean much. To know how good your CAC is, it must be looked at in light of each customer’s LTV. Your LTV must always be greater than your CAC. Research shows that for your SaaS business to succeed, your LTV:CAC ratio must be more than 3:1.
Revenue Per Lead (RPL)
Revenue Per Lead measures the average amount of revenue each lead you generate will contribute to your overall revenue. Calculating RPL on a per-sales-person basis gives you valuable insight into the overall efficiency of your sales team and processes. It also provides a benchmark of which sales reps are best at closing certain types of customers.
Find out how to calculate some of the key SaaS metrics here.
Key SaaS customer success metrics
While customer acquisition may seem like the ultimate means to growing your SaaS business, it’s only half the story. When a SaaS business starts gaining traction, you must place more emphasis on customer success. Here are some essential SaaS customer success metrics you can use to check if your intended business purchase is doing well in this area:
Daily Active Users (DAU)
Daily active users (DAU), is a metric that shows the number of people who log in to use your product on a given day. To create a helpful way of measuring DAU is to define what qualifies as an active user of your product. For most SaaS brands, DAU refers to the number of people who logged into your platform.
Monthly Active Users (MAU)
Like DAU, the monthly active users (MAU) metric refers to the number of people who have logged into your platform to use it in a given month. DAU and MAU are useful for checking engagement rates. The closer the DAU:MAU ratio is to 100%, the more satisfied and engaged your users are with your product. It indicates the probability of higher retention rates.
Net Promoter Score (NPS)
The Net Promoter Score (NPS) is a tool used to gauge customer satisfaction. The tool usesnone survey question to do this — “How likely are you to recommend [product] to a friend or a colleague?” Respondents can choose a score on a scale from 0 (“Not at all likely”) to 10 (“Extremely likely”).
The NPS is then calculated by subtracting the percentage of “Detractors” from the percentage of “Promoters”. A positive NPS shows a higher likely hood of people being happy enough with your product to recommend it to friends and colleagues.
Source code review
Every SaaS business is built on the efficacy of the source code. That’s why you must always review the source code of the SaaS product the business you intend to buy deals in. after all, you don’t want to buy a SaaS business whose product source code is poorly written, outdated, unworkable, or even copied. If you don’t have the technical knowledge to review the source code yourself, you can hire someone who has. If the source code a developer
Before buying a SaaS business, ensure the source code has proper documentation and is built on a modern framework.
Intellectual property review
One of the most important legal aspects of due diligence you should conduct when buying a SaaS business is reviewing and understanding intellectual property (IP) agreements. You must assess any IP the business claims to own and whether it’s appropriately protected. IP ownership issues can come back to bite you in the future if due diligence hasn’t been completed in this area. This is especially if third-party developers were used to write all or parts of the source code and have not properly assigned the IP to the company.
There are times when the business relies on the IP of others to fulfill its obligations. In this case, a thorough review of third-party contracts should be conducted to determine if there are any weaknesses in the chain of intellectual property.
Due to the recurrent nature of the SaaS business model, customer support plays an integral role in the success of every SaaS business. After all, your customer support has a huge bearing on customer satisfaction (NPS) and the rate at which you retain customers.
Evaluating the customer support system of your target SaaS business is a critical aspect of conducting due diligence. As such, you must evaluate every aspect of your customer support process.
Understand if the customer support is in-house or contracted with a third party. What are the contractual terms or tailored levels of support? Are there service level agreements (SLAs) promised as part of the subscription service and does a third party meet them?
You must go beyond just checking customer support resources and dig deep into metrics such as (among others):
- Time to first response
- Number of tickets submitted every week
- Resolution times
You’ll also want to see how problems get solved as this impacts the overall customer experience (CX). It’s essential to the business’s survival that you do everything in your power to retain valuable customers. And customer support is a crucial tool for this.
Buying a software business can be complicated if you don’t know what to look for. After all, there are many SaaS solutions and businesses that may look enticing on the surface level but may have some deep-seated.
Use this post as a SaaS business due diligence checklist and the task will become much easier.
As you conduct your due diligence, make sure not to dismiss a business just because it lacks in a certain area. Sometimes all it needs is a savvy investor who can help turn it into a lucrative business.
If you’re interested in buying a SaaS business, make sure to check out our portfolio of available SaaS investment opportunities. As a platform for buying and selling SaaS businesses (along with any other online business!), Flippa gives you the chance to find the right business for you, or the right buyer for your business.