SaaS due diligence

SaaS due diligence

Before investing in a SaaS business, it is worth hiring experts to assist you with the due diligence process. In the following article, we explore what the due diligence process involves and how it assists investors to avoid overpaying and to identify and mitigate risks. 

What is a Due Diligence?

Due diligence is a comprehensive examination of a company’s financial, fiscal, legal and operational information that is conducted by a potential buyer, investor or lender. The purpose of due diligence is to assess the risks, strengths and opportunities of a business and to determine whether the investment is suitable and worthwhile. Due diligence is usually performed before an acquisition, merger, investment or financing transaction, and its outcome can influence the negotiation and finalization of the deal.

Principal aspects of the due diligence of a SaaS business

The due diligence of a SaaS (Software as a Service) business requires a focus on both general aspects that determine the equity value of almost any business and on certain specific aspects that are relevant to the industry. The following are the most important areas of a SaaS due diligence:

General aspects evaluated during the due diligence

The examination of the company’s financial statements, budgets, forecasts, and cash flows is essential to assess the stability and growth potential of the business. The analysis of the company’s revenue, gross margin, operating expenses, and adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) helps the investor determine the profitability and efficiency of the business.

Furthermore, it is the adjusted EBITDA figure, along with net debt and the normal level of working, that are key due diligence areas as they determine the price that the investor pays for the shares (equity value). Unlike traditional EBITDA, adjusted EBITDA takes into account non-recurring and one-time items such as restructuring charges, legal fees, and other expenses that are not considered to be part of the company’s normal operations. The purpose of adjusting EBITDA is to remove the effects of these one-time expenses and provide a more accurate picture of the company’s true financial performance. Any adjustments to EBITDA, net debt or working capital detected during the due diligence will have an impact on the valuation of the company.  

Another important aspect to evaluate during the due diligence of almost any company is the management team, employees, and organizational structure, which are essential to determine the stability and capabilities of the business. The analysis of the company’s culture, values, and leadership style is crucial to assess the potential for future growth and success.

Aspects specific to the due diligence of SaaS businesses

The analysis of the customer base, sales channels, and marketing strategies is necessary to evaluate the scalability and sustainability of the business. The examination of the customer churn rate (the percentage of customers who cancel their subscription), the Monthly Recurring Revenues (MRR), the Customer Acquisition Cost (CAC) and the Customer Lifetime Value (CLV) are essential to assess the growth potential and the viability of the business.

The examination of the company’s technology and product offerings, including the software architecture, intellectual property, security, and compliance, is key to assess both the risk and future scalability of the business. The analysis of the company’s product roadmap, development pipeline, and technology trends is crucial to determine the potential for future growth and innovation.

Recommendations and legal aspects to take into account

In addition to the above areas of focus, there are several recommendations and legal aspects to take into account during the due diligence of SaaS businesses:

The examination of the company’s contracts, legal agreements, and liabilities is essential to assess the risk and value of the business. The analysis of the company’s compliance with applicable laws and regulations, including data protection and privacy, is crucial to ensure the viability and sustainability of the business.

The review of the company’s information security policies, procedures, and systems is important to assess the risk and the company’s value. The analysis of the company’s data protection and privacy policies, including the storage and processing of personal data, is necessary to ensure the sustainability of the business.

Hire experts

The due diligence process can be complex and time-consuming, and it is recommended to involve experts such as accountants, lawyers, and tax advisors, to ensure a thorough analysis, quantify potential price adjustments and mitigate risks.