Anyone selling a software business encounters a valuation logic that differs sharply from a classic mid-market transaction. A machine builder is valued on EBITDA, a growing B2B SaaS company on recurring revenue, often while still loss-making. Buyers are not paying for current profit but for the predictability of future cash flows. Understanding that logic is the first step to influencing your own multiple.
Why ARR replaces EBITDA as the reference
Annual Recurring Revenue, the contractually committed revenue annualised over twelve months, is the central figure in any B2B SaaS valuation. The reason lies in the cost structure: a growing software company spends sales and development money today to harvest revenue for years. That artificially depresses EBITDA without any lack of earning power, so earnings-based multiples would punish exactly those companies growing fastest.
The market therefore works with ARR multiples, cross-checked against a DCF view. The range is wide, from roughly two to more than ten times ARR. Where a company lands is decided not by the size of its ARR but by its quality, as we set out in our article on valuation using multiples and DCF.
The quality metrics behind the multiple
Four metrics decide the premium or discount. Net revenue retention measures how a cohort develops without new customers. Above 100 percent means the company grows even if it never wins another logo, which is the single strongest signal for a buyer. Logo churn shows how many customers leave, and is judged very differently for mid-market accounts than for micro customers.
CAC payback quantifies how many months it takes to recover the sales cost of a new customer. Under twelve months is strong, over twenty-four needs explaining. And gross margin on recurring revenue separates genuine software from revenue-heavy services: at sixty percent margin you are probably selling implementation hours with a licence attached.
The Rule of 40 as a summary
The Rule of 40 condenses growth and profitability into one number: growth rate in percent plus operating margin in percent should be at least forty. A company growing sixty percent with a twenty percent loss scores the same as one growing fifteen percent at a twenty-five percent margin. Both profiles are investable but appeal to different buyers.
That is precisely its practical value in sale preparation. If you sit below forty, decide before the process which lever you pull. Improving margin by five points is usually easier than accelerating growth by five points, and a well-argued profile beats any retrospective explanation.
What buyers examine in due diligence
In due diligence the ARR is taken apart, not taken on trust. Buyers separate contractually committed from merely habitual revenue, check notice periods, price escalators and how many contracts expire within twelve months. One-off setup fees, hardware and consulting revenue drop out of ARR, and part of the purchase price goes with them.
Customer concentration is the second checkpoint. If three customers carry forty percent of ARR, the multiple falls regardless of every other metric. Technical debt and dependence on individual developers rank close behind. A prepared data set with clean cohort analysis stops these topics surfacing late and being used as price arguments, and our piece on private equity versus strategic buyers shows how differently each group weighs them.
FAQ
At what size do buyers become interested in a B2B SaaS business? Strategic buyers often engage from around one million in ARR if product and customer list fit. Institutional investors typically expect considerably more, but also more robust cohort data.
Is a loss a problem when selling? Not in itself. What matters is whether the loss stems from growth investment and whether the unit economics work. A loss at flat revenue is a completely different story from a loss at seventy percent growth.
How far ahead should the metrics be cleaned up? At least four quarters, because buyers want to see cohorts over time. A metric framework introduced shortly before the process looks constructed.