Donovan: Free cash flow margin explains 40% of SaaS valuation multiples
Jeremey Donovan · How We Help ScaleUps Measure Efficient Growth · May 4, 2023 · at 7:21
This episode carries Jeremey Donovan's own address, with nobody on the show putting questions to them. It still counts as said, and it is kept out of every score on their page.
Jeremey Donovan argues that disaggregating Rule of 40 into standalone free cash flow margin yields much higher predictive power for SaaS multiples.
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“40% of the variation in Multiple can be explained by variation in free cash flow margin.”
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More from Jeremey Donovan
Donovan: Rule of 40 had zero correlation with SaaS multiples before Q2 2022
“So if you just use rule of 40 where you composite, you smoosh growth and efficiency together, until Q two of last year, there was actually no correlation. So, like, I would have called total BS on using rule of 40 by itself before Q two of last year. It just w…”
Donovan: Rule of 40 SaaS valuation premium increased from 1.5x to 2x
“If you were to take all the data that's in the 20, the zero, the under zero to up to 40, and then compare that to the over 40, it was about 1.5 x higher for the people who were over 40 before. And now it's two x higher if you're over 40.”
Donovan: Rule of 40 explains 21% of SaaS multiple variation post-Q2 2022
“Now, 21% of the variation in multiple is explained by variation in rule of 40, but you can do better.”
Donovan: SaaS multiples had no statistical link to margins or CAC pre-2022
“What is kind of surprising is during that period, there was no statistical relationship between your multiple and your margin, your gross margin, or your CAC, your sales and marketing efficiency.”
Donovan: R&D spending variation no longer predicts SaaS valuation multiples
“Interestingly enough, R&D, which the more you spent on R&D before, the stronger your multiple was, because you were investing for growth, now it's neutral. That very, like, there is no predictive, very, The variation in R&D spend does not have any predictive v…”
Donovan: Insight recommends setting sales quota-to-OTE multiple at 5x
“We recommend, from Insight, we recommend that you set quota to OTE, or OTE to quota multiple at five X, so your 20% cost of sales on new business. You know, we were routinely seeing four X in our, in the companies that we were funding, as well as just out ther…”