In our Value Builder series we explore the eight key factors potential buyers review when looking to acquire a business, maybe yours!
The Hierarchy of Recurring Business Revenue
“First, you work for money, and then money works for you.” – Idowu Koyenikan, Wealth for All: Living a Life of Success at the Edge of Your Ability
One of the most important factors in determining the value of your company is the extent to which an acquirer can predict where your sales will come from in the future. If you’re in a business that must start from scratch each month, the value of your company will be lower than if you can pinpoint the source of your future revenue.
A recurring revenue stream acts like a powerful pair of binoculars for you to see months – even years – into the future, so creating an annuity stream is the best way to increase the value of your business.
There are various forms of recurring revenue. The more certain your future revenue is, the higher the value the market will place on your business. The list below outlines six forms of recurring revenue presented from least to most valuable in the eyes of an acquirer:
No. 6: Consumables (e.g., toothpaste)
Consumables are disposable items like shampoo and toothpaste that customers purchase regularly but where there isn’t a solid motivation from them to repurchase or to be brand-loyal.
More valuable than a straightforward consumables business is one centered around “sunk-money consumables.” The customer first makes an investment in a “platform.” For example, once you buy a razor, you have sunk money into a platform and have a vested interest in buying the compatible blades going forward.
No.4: Renewable subscriptions (e.g., magazines)
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future in the form of a subscription. Typically, subscriptions are paid for in advance, making them an excellent way to create a positive cash-flow cycle and wean your business off a reliance on bank financing.
No.3: Sunk-money renewable subscriptions (e.g., the Bloomberg Terminal)
Traders and money managers swear by their Bloomberg Terminal. Bloomberg customers have to first buy or lease the terminal and then subscribe to Bloomberg’s financial information. Having sticky customers loyal to a proprietary platform allowed Michael Bloomberg to build a valuable company
When you store documents with Iron Mountain, you are charged a fee each month until you decide to pick up your documents. Unlike a magazine subscription, for which you have to make the conscious decision to cancel, Iron Mountain just bills you until you tell it to stop.
No.1: Contracts (e.g., wireless phones)
The only thing more valuable than an automatic-renewal subscription is a hard contract for a defined term. As much as we may despise being tied to them, wireless companies have mastered the art of recurring revenue. Many give customers free phones as long as the customer locks into a two or three-year full-service contract.
Think of the list above like a ladder. Each rung you climb on the way toward number one, the more valuable your business will be!
A complimentary Value Builder questionnaire available from The Osborne Group will provide an assessment of the current potential sales value of your company. The questionnaire is part of a system developed by internationally recognized small business expert John Warrillow with results based on findings from over 17,000 companies. Your answers will help determine what drives up, or undermines, your company’s value and steps you could take to increase its value.
The questionnaire takes just 15 minutes to complete online and generates a detailed report that an Osborne Group Certified Value Builder consultant will review with you during a complimentary two-hour meeting.
In future blogs, we’ll examine other Value Builder factors and their impact on your company’s worth. Follow us here for the series:
