How to Build Recurring Revenue: A Key to a Valuable Business
Recurring revenue is the holy grail for business owners looking to have a valuable and sellable company. Learn how to secure stable and predictable cash flow in your business.
Recurring revenue is the holy grail for business owners looking to have a valuable and sellable company. A customer base with a subset of 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 perceived value. 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 transaction value.
Although all recurring revenue will have a positive impact on business value, some forms are more desirable than others. Here are a list of the types of recurring revenue in an order from good to best.
If you sell a consumable product — whether it be diapers, commercial cleaning supplies or office supplies — start tracking your repurchase rate from existing customers. This will be a number that buyers will use to calculate your projected sales into the future and calculate how much they’re willing to pay to buy your company today.
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future. For example, loyal subscribers 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. For instance, we use Mozy.com to automatically backup some of our office computers online on a daily basis and are charged a fee each month. This subscription service has no end date unless we tell them to stop providing the service. GoToMyPC.com also operates in this manner. By tracking historic cancellation rates, revenues can be predicted well into the future, which is why these types of revenue streams enjoy higher valuations.
The only thing more valuable than an automatic renewal subscription is a hard contract for a defined term. Wireless cell phone companies come to mind as one of those industries that push hard to get you on a multi-year contract. When a company is acquired, the owner and some employees may leave after the acquisition. But customers with plenty of time remaining on their contracts are security for the acquirer. As you ascend the recurring-revenue hierarchy, the value of the business will go up accordingly.
Recurring Revenue Models for Your Business
Do you think that recurring revenue is tough to achieve in your business? Here are some examples of recurring revenue models that might spark some ideas:
- maintenance contracts
- monthly support agreements
- annual license agreements
- 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 maintenance companies
- pool service companies
- janitorial companies
Benefits of Recurring Revenue
The recurring revenue customer base you build for your company will:
- Increase the probability that you will have stable revenues and cash flow
- Decrease future risk in the mind of a potential buyer
- Provide you with an opportunity to sell additional products or services to your existing customer base
- Keep you more attuned to your customer needs while helping you ward off competition
- Provide a corporate buyer with the opportunity to cross-sell its products to your customers
- Provide a justification for a higher sale price of your business
Ensuring your company has a predicatable and stable revenue base will mitigate risk in your business and lead to a much higher valuation.
Learn more about the Ten Value Drivers That Increase Sale Price of a Business