Question
How does recurring revenue affect business valuation?
Answer
Building a business with more recurring revenue, as opposed to one with one-off revenue, has almost a direct correlation to an improvement in valuation. You can see it in virtually every industry that exists in the world.
Take, for example, the alarm security business. Alarm companies generate two types of revenue. You’ve got the installation revenue and you’ve got the monitoring revenue. The installation revenue obviously is one-off revenue. If you have an alarm company generation 100% of its revenue from just installations, it would be worth about 75 cents on the dollar. whereas if you have an alarm company that has 100% recurring monitoring revenue, that’s worth about $2 for every $1 of revenue. So if you think about it, it’s about three times more valuable.
This valuation premium is not unique to the security business. Recurring revenue has a dramatic and positive effect on virtually every business, so if you’re talking about a financial planning practice, it will be valued based on the annuity stream. If you’re talking about accounting firms, valuation is based on the gross recurring fees from clients. Obviously, SaaS based software companies are valued based on the multiple of their recurring revenue. So again, building a business with a recurring revenue model, significantly increases business value.
Take, for example, the alarm security business. Alarm companies generate two types of revenue. You’ve got the installation revenue and you’ve got the monitoring revenue. The installation revenue obviously is one-off revenue. If you have an alarm company generation 100% of its revenue from just installations, it would be worth about 75 cents on the dollar. whereas if you have an alarm company that has 100% recurring monitoring revenue, that’s worth about $2 for every $1 of revenue. So if you think about it, it’s about three times more valuable.
This valuation premium is not unique to the security business. Recurring revenue has a dramatic and positive effect on virtually every business, so if you’re talking about a financial planning practice, it will be valued based on the annuity stream. If you’re talking about accounting firms, valuation is based on the gross recurring fees from clients. Obviously, SaaS based software companies are valued based on the multiple of their recurring revenue. So again, building a business with a recurring revenue model, significantly increases business value.
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Written by John Warrillow
John Warrillow is the founder of The Sellability Score and author of the book "Built to Sell: Creating a Business That Can Thrive Without You". Throughout his career, John has started and exited four companies and is a sought-after speaker and angel investor.
John's new book, The Automatic Customer: Creating a Subscription Business in Any Industry, is scheduled to be released in February 2015.
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