05 Nov Why SaaS is My Favorite Business Model
I’ve dabbled — in some cases quite heavily — into a number of varied and crazy business models over the last several years. Some of the virtually-based, others more real. All of them have married technology, even if the technology was somehow already embedded in the service offering. Each instance of exploration becomes a learning experience in its own right, wherein “best practices” become the proverbial cream that eventually rises to the top.
While I’ve not experimented with some forms of business growth, including those that require a bit of creative financial engineering, I would say because of my work in M&A, that even if I haven’t operated a particular niche, that I’ve had the unique experience of looking under the hood of literally dozens of companies–good and bad–to see what makes them tick.
In doing so, I’ve found a few models that I would absolutely love to replicate. Among them, are those operating software-as-a-service businesses where hosting, both individual and enterprise makes up the lion’s share of corporate revenue.
I love the idea of predictable profits. When advising companies who may be struggling, in some cases the costs got wildly out of control because revenue predictability was unstable. In companies looking to grow, costs are often ignored at the expensive of growing the top-line. Moving from growth to stability becomes the hiccup that can tank start-ups looking to edge to the next level. Revenue from SaaS, PaaS or IaaS creates a much more predictable ecosystem for corporate growth.
The nature of today’s risky business environment favors predictability. It helps to lessen the risk burden faced by many companies and management who may be concerned with our fiscal future.
When it comes to scaled cash and cash growth, nothing beats hosting–nothing. With the right infrastructure in place, nearly anything is possible. Here’s a simple for instance. One of the companies I currently advise runs a enterprise-based SaaS solution. They currently have 20K+ hosted nodes running high-definition unstructured data. They’re doing it on five servers each of which has a hardware cost of about $700 each. Talk about return on investment.
Residual Cash Flows
Like real estate, hosting revenues provide a continual stream of residual income.
When firms look to invest in other markets that may be outside the initial wheelhouse of some form of cloud hosting, they can point to such hosting contracts as a viable stream from which to borrow against. In fact, I can think of two corporate finance firms that I’ve met with recently that provide bridge loans, direct asset purchases loans and large debt financing rounds thanks to the large residual cash flows coming into the business. This is a massive benefit to companies looking for quick cash without having to forfeit equity to do so. A great example is a SaaS or PaaS-based company with long-term contract with the United States Military. The contract will certainly involve an upfront cost that may be prohibitive to the company, but for which the eventual income on the back-end makes the project extremely enticing.
Getting a great interest rate from non-bank lenders (unfortunately, banks have been hesitant of late to provide financing in some of these types of unique situations) is much more easy when you’ve a predictable “contract-based” income stream from hosting revenues or something similar. Residual cash flows that are highly-predictable also makes corporate valuation that much easier because such streams can be more easily discounted.
The features previously mentioned help to contribute to strong multiples for business valuations in this space. Strong multiples means a greater payout or bang-for-your-buck when it comes time to sell the business. In short, investors–both strategic and financial–typically pay a premium for companies with all the other features mentioned above.
Perhaps one of the greatest reasons I love SaaS business models is the fact that they include all the elements of the new digital economy: finance, technology, marketing and operations into a single one-stop-shop. What’s your favorite business model?