How do you value prepaid subscriptions in a SaaS deal?
April 16, 2021
by a searcher from Carnegie Mellon University - Tepper School of Business in San Jose, CA, USA
The SaaS and Software deal experts: How do you value or adjust the price for the future subscription revenue that has already been realized by the owner. A proprietary deal I am working on has almost 40% of their revenue in prepaid annual subscriptions and 10% in 3-year prepaid subscriptions. To make it worse, they also have many lifetime subscriptions they sold years ago to get the traction many years ago! Surely, I am not going to see any revenue from these customers for 1-3 years. but have marginal cost to service and support them. 1. How do suggest structure such a deal? 2. Do debt providers/banks evaluate the annual or multi-year subscription revenue differently than the monthly subscription revenue?
from The University of Chicago in Chicago, IL, USA
Fir a start-up SaaS company, yr-1 sales are $1 million, uniform monthly from one customer X. All are cash sales, no A/R. COGS 65%, Admin 20%, 15% EBITDA.. There is no deferred revenue for 364 days. On the 365th day, a customer Y walks in and pays $1 M and says, here is an advance payment for 1 yr of service. Just make sure you take care of me. Now balance sheet shows $1 M cash and $1 M deferred revenue. The buyer buys the business in the 1st week of yr-2.. Buyer pays some purchase price P and assumes deferred revenue liability. Seller keeps the cash. Buyer is following the debt-free, cash-free teachings. He has negative working capital. (This is what I often here that in SaaS transactions WC is often negative.) Now, in the 2nd week of yr-2, just after the Closing, Pandemic kicks in, Customer X closes the business, but customer Y doors are open. Now the buyer has to service the customer Y but has no cash coking in. He is going to be in trouble big times.
Above is a simplified example to point out that just because some have done the SaaS transaction with negative WC does not mean that is the proper. many times SaaS businesses are growing and variable cost is low. These factors mask the assumption of deferred revenue. It is unfortunate that the industry often runs on sheep mentality of following others. (Note: there are certain situations when a buyer should assume deferred revenue liability, but this is not the place to go into that.)
from The University of Chicago in Chicago, IL, USA
1) pre-paid subscription is not revenue until service is provided. Hopefully your target is recording PPD $ of 100 as cash of $100 and PPD liability of $100, Then recognizing revenue as service is provided. As part of the price you should get the cash of $100 and assume the PPD liability of $100. There are some variations to this depending on certain specifics.
2) Life time subscriptions: No impact on deal or price as long as these subscriptions occurred a while ago b/c the expenses associated with servicing these subscriptions is already in the P&L, hoping the such cost is static going forward.