Industry
Why investors are wary of SaaS startups, apart from rock-bottom valuations
Summary
- Factors such as high interest rates and limited global market access contribute to poor growth prospects.
Four years after the covid pandemic fuelled a technology services boom, valuations of software as service (SaaS) firms have plunged to near-historic lows. Still, high interest rates and fears of slower growth are holding back fresh investments, multiple investors said.
SaaS valuations began rising in April 2020, alongside rising deal flows. In September 2023, Freshworks listed on Nasdaq at a valuation of $13.5 billion. Others such as Chargebee, Icertis and Innovacer also raised private capital at high multiples. However, for valuations, it was a different story.
According to M&A advisory firm Aventis Advisors, the median EV/revenue multiple—used to value SaaS companies comparing enterprise value to sales—rose from a covid bottom of 9.8X to almost 20x in 2021. It stayed around 18-19x levels most of the year, before plunging to 6.7x by early 2023. At the end of the December quarter, the ratio stood at 7.2x.
“There are a lot of late-stage funds that have raised sizeable capital in the last few years. But what tends to happen is, people are all going to the same set of very few companies to fund. And in general, therefore, with funding, the bar has gone up," said Alok Goyal, partner at Stellaris Venture Partners.
Among the reasons are the weak sentiments in IT stocks, and high interest rates that impact the value of future cash flows.
"The recent decline in SaaS valuations can be attributed to several factors such as the recent decline in public markets in IT sector, high interest rates globally leading to general flight of international capital, coupled with the low growth of Indian SaaS products (specifically, HR tech)," said Vinay Bansal, founder & CEO, Inflection Point Ventures. “Additionally, the inability to venture into more lucrative global markets have further dampened SaaS valuations," Bansal said.
As with other sectors, SaaS investors are focusing on companies with good fundamentals, with a clear path to profitability. This phase is likely to persist for up to 6-12 months, investors said.
"Good founders will continue to get funded. But there is a lot of disruption happening as well. A lot of new companies are getting created as well, and people -- both entrepreneurs and investors -- are excited about those ideas. I don't think that this is a low valuation environment for early stage," Goyal said.
In late-stage companies, if founders have raised capital at high valuations, then they need to grow into that valuation, and then go to market, Goyal added. "Or you have to raise a down round, which nobody wants to do – so people end up just waiting a lot longer," Goyal said.
IPV’s Bansal foresees this phase being short-lived. “I anticipate this phase to persist for approximately six months. I remain optimistic that we will see improvements beyond this timeframe as the market adjusts and investment sentiments stabilise," he said.
Despite the subdued valuations, some investors remain optimistic. “We are bullish on the Indian SaaS industry," said Bhavik Vasa, founder and CEO of GetVantage, which provides revenue-based financing to startups. “We have a committed corpus of ₹250 crore to fuel this sector over the next 12-18 months."
