ARR Multiple

What is an ARR Multiple?

ARR Multiples compare a company's market value to its Annual Recurring Revenue (ARR) to gauge how highly the market values the company's current revenue streams.

ARR Multiples are the basis on which SaaS companies are generally valued, as opposed to the P/E ratios primarily used to value non-SaaS public companies. Because SaaS businesses often operate at a loss in their early stages due to upfront investments in growth (e.g., the Triangle of Despair), profitability can take time to achieve, making P/E ratios less relevant.

Instead, ARR Multiples provide a snapshot of how revenues might scale without expecting immediate profitability. This metric answers the question: "If you buy a company at its current valuation, how long will it take to earn back your investment based on its current ARR?"

How to calculate an ARR Multiple

An ARR Multiple is calculated by dividing a company's valuation by its Annual Recurring Revenue (ARR):

$$\text{ARR Multiple}=\frac{\text{Current Valuation}}{\text{Current ARR}}$$

For instance, if a SaaS company is valued at $100 million and its ARR is $10 million, the ARR Multiple would be 10x. This straightforward calculation provides a quick way to compare different companies' valuations and assess whether a SaaS company is potentially under- or overvalued in the market.

Benchmarks

The magnitude of an ARR Multiple can vary significantly based on external market conditions that influence the time value of money, such as interest rates. During periods of low interest rates, SaaS companies tend to enjoy higher valuations due to the cheaper cost of capital and a stronger preference for growth-oriented investments with high risk but higher potential upside.

Conversely, higher rates tend to increase the attractiveness of other investment vehicles like bonds, in turn clobbering ARR Multiples. While a typical benchmark for ARR Multiples in early 2023 was around 6x for U.S. SaaS companies, this was a significant decline from the highs of 15-20x we saw in the low-interest environment of 2021. Now that's a decent haircut!

In addition to market conditions, business dynamics like retention rates and operating efficiency are crucial in shaping ARR Multiples. SaaS companies are valued particularly for their predictable, recurring revenue models. Investors prize this predictability, which is why companies that can demonstrate sustained or growing ARR and high retention alongside efficient growth strategies (as demonstrated by the Magic Number, Gross Margin, and LTV:CAC) often command higher multiples.