Businesses are typically value based on their ability to generate profits in the future and the risk associated with these future earnings. Businesses that earn steady, predictable, and consistent income will generally be valued higher than businesses that do not. This is why recurring revenue is can be an important factor to consider for business owners looking grow the value of their business. Having a customer base that at least partially earns recurring revenue that is contractual and repeating in nature increases the probability that the business will have stable, predictable revenues and cash flow into the future.
From a buyer’s perspective, this reduces future risk and therefore enhances the perceived value of the business. The value associated with acquiring the available cash flow is directly related to risk. The lower the risk of losing that cash flow in a transfer of ownership, the higher the price will be to acquire it. Any factor that reduces risk is rewarded with added value.
Although all recurring revenue will have a positive impact on business value, some forms are more desirable than others. Here is a list of various types of recurring revenue in an order from good to best.
If you sell a consumable product, find ways to track the rate at which your existing customers repurchase. This will be a number is useful to potential buyers, and can help to exhibit potential areas of growth in your business.
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future. For example, subscriptions to magazines, newspapers, and other publications get a renewal letter each year and pay upfront for the next 12 issues. They make the conscious decision to renew into the future for a certain period of time.
Automatically-renewed subscriptions are even more attractive than periodic renewals because they require a conscious decision to cancel rather than renew. By tracking historic cancellation rates revenues can be predicted well into the future, which is why these types of revenue streams enjoy higher valuations.
Memberships are very much like subscriptions, as they are another form of automatically-renewed revenue model that is almost guaranteed month to month. Your gym membership may come to mind as one that fits this model.
The only thing more valuable than an automatic renewal subscription is a contract for a defined term. When a company is acquired, the owner and some employees may leave after the acquisition. However, customers with time remaining on their contracts are security for the buyer. By locking in your best customers to multi-year contracts, you can create significant business value.
Here are some examples of recurring revenue models that might spark some ideas for your business:
- maintenance contracts
- monthly support agreements
- annual license agreements
- monthly or annual memberships
- accounting firms that provide annual tax return preparation and audits
- security firms that monitor home and commercial businesses on a monthly basis
- HVAC companies that perform routine maintenance of equipment
- software companies that provide annual user support and software upgrades for a maintenance fee
- landscape and property maintenance companies
- pool service companies
- janitorial companies
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