Case 084SaaS metrics and diagnosticsCore

How would you value a B2B SaaS company? Value Hisabvik Systems: ARR Rs 45 crore, next-year growth 60%, NRR 118%, gross margin 78%, free cash flow margin minus 20%. Peers trade from 6x to 14x next-year ARR, the top reserved for growth above 50% and NRR above 115%. Derive a range and a point.

Battery VenturesBoston · 2022

The situation

Hisabvik Systems sells accounting and compliance software to mid-sized Indian businesses on annual contracts. ARR is Rs 45 crore and the plan, which your team has checked against the pipeline, shows 60% growth next year. Net revenue retention (NRR) is 118%: a group of customers paying Rs 100 a year ago pays Rs 118 today after upgrades, seat additions and churn. Gross margin is 78% and free cash flow is minus 20% of revenue.

Listed and recently funded peers trade between 6x and 14x next-year ARR. Your partner's rule of thumb is that the upper half of that range is for companies growing above 50% with NRR above 115%.

Your task

Value Hisabvik: give the range, a point inside it, and the metrics that justify where you put it.

Quick check

What is the value range on these peer multiples?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

On Rs 72 crore of next-year ARR the range is Rs 432 to 1,008 crore, and I would put Hisabvik at 12x, Rs 864 crore. It clears both bars for the upper half: 60% growth and 118% NRR, which alone delivers Rs 8.1 crore of next year's growth. It stops short of 14x because it burns 20% of revenue, putting it exactly at the rule of 40 rather than above it.

Step 1What do you multiply, and why next year's ARR?

When you buy a rented flat you look at the rent it will earn, not the rent it earned last year, if a new lease is already signed. Software investors value on next-year ARR for the same reason: the contracts and pipeline for next year are largely visible, and the peer multiples are quoted on that basis. Rs 45 crore growing 60% is Rs 72 crore. The first error to avoid is applying a next-year multiple to this year's revenue, which would understate the range by 38%.

The relationship

45 \times 1.60 = 72 \qquad 6 \times 72 = 432 \qquad 14 \times 72 = 1{,}008

45	current ARR, Rs crore
1.60	one year of 60% growth
6 and 14	the peer range of next-year ARR multiples

What it says in wordsGrow the ARR one year, then apply the peer range to it.

Step 2Why does NRR earn the upper half?

NRR of 118% means today's customers will pay 18% more next year without any new selling. On Rs 45 crore that is Rs 8.1 crore of growth arriving free of acquisition cost, 30% of the Rs 27 crore Hisabvik needs to add. Only Rs 18.9 crore has to come from new customers. A company with 100% NRR would need all Rs 27 crore from new logos, at full sales cost. That is why investors pay up for retention: it is growth that does not have to be bought.

Of the Rs 27 crore Hisabvik adds next year, Rs 8.1 crore comes from existing customers at 118% NRR and only Rs 18.9 crore must be won from new ones, which is why retention earns a higher multiple.

Step 3Where in the upper half, and what holds it back from 14x?

Hisabvik clears both tests for the upper half: growth of 60% against a 50% bar and NRR of 118% against 115%. Gross margin of 78% is healthy for software. What holds it below 14x is cash: free cash flow of minus 20% of revenue means growth of 60% plus a cash margin of minus 20% sums to exactly 40, on the rule-of-40 line rather than above it. The rule of 40A shorthand test that adds revenue growth and free cash flow margin, both in per cent; 40 or more is taken as a healthy balance of growth and cash. is a rough screen, not a law, but it is the screen peers at 14x usually pass with room to spare. I would put the point at 12x, Rs 864 crore.

Hisabvik's range on Rs 72 crore of next-year ARR runs from Rs 432 to 1,008 crore; its growth and NRR earn the upper half, and its minus 20% cash margin sets the point at 12x, Rs 864 crore, rather than at the top.

Metric	Hisabvik	Bar for top half	Effect on point
Next-year growth	60%	above 50%	pushes up
Net revenue retention	118%	above 115%	pushes up
Gross margin	78%	healthy for software	neutral
Free cash flow margin	-20%	growth + FCF above 40	holds back from 14x
Point	12x	Rs 864 crore

Two metrics push Hisabvik into the upper half and the cash burn holds it there at 12x, which is Rs 864 crore on next-year ARR and about 19.2x this year's ARR.

Step 4What would move the point, and what are the limits?

Watch two things. If NRR slipped to 110% the upper half would no longer be earned and the point would fall towards 10x, Rs 720 crore, a drop of Rs 144 crore on one metric. If the cash margin improved to minus 5% at the same growth, Hisabvik would be well above the rule of 40 and 13x to 14x becomes defensible. Also quote the point on current ARR, 19.2x, because a founder will compare it with headlines quoted that way. The limit: peer multiples move with the market, so the range is a reading of today's prices, and the point is a judgement about rank within it, not a fair value.

Where candidates lose it

The most common error is applying 6x to 14x to the current Rs 45 crore. The peers are quoted on next-year ARR, so the range must be built on Rs 72 crore, and mixing the two bases understates value by 38%.

The second is reaching for 14x because growth and NRR both clear the bar, without asking what the burn says. A company at exactly the rule of 40 is good, not the best in its peer set.

What the interviewer asks next

NRR is 118% on average but 95% for customers under Rs 5 lakh a year. Does that change your point?
How would you check that the 60% growth plan is real before valuing on it?
Value Hisabvik on a discounted cash flow instead. Which inputs would dominate?
Why do investors sometimes prefer gross margin-adjusted ARR multiples?

Asked at Battery Ventures, Software, Boston, 2022 (Wall Street Oasis): SaaS metrics - how would you value a B2B SaaS company

Company names and figures are illustrative.