Thursday, August 30, 2012

Key Value Drivers - The Hierarchy of Recurring Revenue

The customer base is a key value driver for most businesses.  In addition to a diversified client base and the potential for future revenue growth, purchasers are very interested in companies that have strong customer relationships that lead to repeat business.
The extent to which future sales can be predicted with some degree of confidence is a major factor in determining the value of a company.  Projections are inherently uncertain and a recurring revenue stream provides greater confidence in the ability to predict future revenues.  Creating a recurring revenue stream is one of the best ways to increase the value of a business and command a higher price in the marketplace.
There are various forms of recurring revenue.  The list below outlines six forms of recurring revenue presented from least to most valuable in the eyes of an acquirer:
6.  Consumables:  disposable items that customers purchase regularly that can be, but are not necessarily, "brand-loyal" such as shampoo, bottled water or batteries.
5.  Sunk money consumables:  disposable items that require an initial investment in a "platform piece" such as razor blades or electric toothbrushes.
4.  Renewable subscriptions:  items that are paid for in advance for a period of time such as magazine subscriptions or monthly passes for public transportation.
3.  Sunk money renewable subscriptions:  products or services that require an initial investment and an ongoing user fee such as a Bloomberg Terminal and corresponding subscription fee for access to the financial information.
2.  Automatic renewal subscriptions:  products or services for which a fee is automatically charged monthly until the client specifically opts out such as document storage or satellite radio subscriptions.
1.  Customer contracts:  products or services that require a hard contract for a pre-defined term such as wireless phone contracts or commercial cleaning services.

The largest transfer of private wealth in history will occur over the coming decade.  The increasing supply of businesses for sale over this time period will create a buyer’s market, in which buyers will only pay top dollar for the most attractive businesses. 
Business owners looking to sell (for a premium) over the coming decade must assess the quality of their existing revenue streams and, where possible, implement measures that will help move them up the hierarchy of recurring revenues.
If you are building a business to sell one day and are curious to see how the quality of your revenue stacks up, take the 13 minute Sellability Score questionnaire:

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