SaaS companies generally have two types of revenue: subscription revenue and professional services revenue. You might have asked the question, Is service revenue included in ARR?
If you’re new to acronyms, ARR is annual recurring revenue. ARR is a SaaS metric used in business valuation (among other things). A simple SaaS valuation formula is ARR x a Company Multiple. Thus, a higher ARR leads to a higher valuation.
SaaS Capital has an answer to this question in their white paper titled “How to Value a SaaS Company.” If your company’s revenue mix is 80% subscription revenue (or higher) to 20% service revenue (or lower), include all of your revenue in ARR. There is not a valuation adjustment for revenue composition.
If your revenue mix contains more than 20% service revenue, there will be a downward adjustment and a lower company valuation.
Why does a higher mix of subscription revenue drive a higher valuation? The answer is because subscription revenue is more valuable than service revenue. There are 2 main reasons for this:
- Subscription revenue is recurring and can last several years.
- Subscription revenue is cheaper to produce than service revenue (i.e., gross margins are higher).
You can find the full white paper from SaaS Capital here.