If you are a business owner, building value is surely top of mind whether you intend to sell in the near term or not. Determining your company’s worth can be personal – especially if you founded the company and have poured countless hours of sweat equity into it. Yet, any investor or buyer will need to feel comfortable that the business offers a product or service with proven demand and can continue to generate consistent revenue after an ownership transition.
As noted in our recent blog post “Drivers of Business Value”, incorporating a recurring revenue model is a strategy that can help your business achieve a stronger valuation. Revenue growth is great to have, but what business owners often don’t focus as much on is the predictability of their revenue. That’s what recurring revenue is all about – decreasing risk by making your future revenue streams safer and more predictable.
Here, we will discuss the benefits of recurring revenue, how it may increase your business’ worth to investors, and ways to consider adding a recurring revenue model to your business.
What is Recurring Revenue?
Recurring revenue represents sales income that is stable, consistent and expected to continue. This type of revenue is different than one-off sales revenue as it occurs at regular intervals and is more predictable, offering financial security that feeds into the future stability of your company.
It is also important to highlight the difference in ‘recurring revenue’ and ‘re-occurring revenue’. Take the example of a favorite grocery or clothing store you regularly visit. While the business may not be sure exactly when you’ll be back, as a repeat buyer there is a good chance you will shop there again and therefore represent a re-occurring revenue stream. The difference in recurring revenue, and what makes it more valuable, is these customers buy from you on a pre-established and usually automatic basis, typically backed by a contract or subscription (such as Netflix, Spotify, Cell-phone plans, etc.).
Your monthly gym membership is a simple example of recurring revenue; the income comes in each month, regardless of how often a member uses the gym. Service contracts and legal agreements are longer-term examples of recurring revenue. Some common examples we see are:
Online software platforms
Land or equipment lease agreements
Retainer agreements for regular professional services
Service agreements that are part of a warranty
Subscribe and save programs
The Importance of Recurring Revenue for a Prospective Buyer
While your business may have a strong and prosperous history, confirmation of expected demand and financial stability is vital to the investment appeal from a buyer's perspective. With a recurring revenue model in place, investors are able to better understand and model:
Expected cash flows – greater accuracy in financial projections and enhanced ability to plan strategically and budget realistically. Having a predictable stream of cash coming in can often reduce a company’s reliance on loans and lines of credit, and the cost associated with taking on debt.
Level of demand – greater visibility into your upcoming demand allows business owners to ensure they have inventory in stock and labour available at the time and level needed.
Risk reduction – recurring revenue models often use auto-payment features which lessens administrative work and reduces the risk of non-payment from customers.
Customer behaviour and churn – subscription and contract models provide data that can be analyzed to understand how to improve a product offering. A recurring revenue model also helps a business foster longer-term relationships with its customers, gather feedback, and provide better overall service.
·Value-add products and service opportunities – repeat customers provide a great platform for marketing potential additional products or services that can add value. Many subscription-based companies do this by offering add-on features or different subscription levels to enhance the user experience
A key priority for any investor is to reduce the risk and increase the return associated with their investment. The above elements are examples of ways to help de-risk a transaction, which will in most cases give a buyer greater comfort to present a higher price and more favourable terms.
Making Recurring Revenue Work for You
Implementation of a recurring revenue model can take many different shapes and forms. For your business it might mean shifting to a membership-based business model, establishing long-term contracts for your service offering, or offering subscriptions for repeat shipments of your product.
Whether you are planning for the sale of your business or not, recurring revenue can be a very valuable asset to your business and enhance your day-to-day operations significantly. The security and predictability derived by a recurring revenue model not only makes your business more appealing to an investor, but also much easier to operate and scale.
Jill Bourchier, CPA