8 Key Drivers Of Company Value (Series) – 5. Recurring Revenue

This series of articles follows on from an article I published recently, titled “8 Key Drivers Of Company Value That Every Business Owner Should Know”, where I mentioned that I use the Value Builder System?? to help small business owners grow the overall value of their companies, by focusing on 8 Key Drivers that impact company value.

At the heart of this system is the Value Builder Score, which determines how well a business is performing in each of those 8 key areas. This series of articles provides some deeper insight into each driver with tips on how to improve in those areas.

But ultimately, what makes this important? It’s every business owners dream to be rewarded for all the hard work they put in over the years when they finally decide to exit, so they get to enjoy a long and happy retirement without financial worries.

So, knowing about these drivers and how to improve them, puts business owners on a path to maximizing the value of their companies while giving them the peace of mind to know that they are growing an asset of value before they exit.

Today we’ll look at Recurring Revenue, which looks at the proportion and quality of automatic, annuity-based revenue you collect each month.

This is how John Warrillow, the founder of the Value Builder System, explains it:

“You know, when a buyer comes in to buy your business, they want to understand, okay, how is this business going to continue when you, the owner, leave, and so the more reoccurring revenue you can have, the more valuable it's going to be. I found that there are really six different forms of reoccurring revenue and buyers view each of the forms a little bit differently. I'm going to give you the six, kind of like a David Letterman's top 10 list. I'll start from the lowest valuable one and end with the most valuable ones in the eyes of an acquirer.

The first of the six forms of reoccurring revenue is simple consumables. So, I'm a coffee drinker. I probably have two a day. In the morning and usually after lunch, I've got to refill on coffee. It's a simple consumables business.

One step up the ladder is a sunk money consumable. You've seen these Nespresso coffee makers, where you've got the machine and then you buy the little capsules. That's called a sunk money subscription. Because you've sunk money into the machine, you're way more likely to buy the capsules from the same company.

Next one up the ladder is subscription revenue. If you've ever subscribed to a magazine, you know about that, right? There's a start date and an end date to your subscription, and the editors know that you're a subscriber for either a year or two years into the future. It's a form of reoccurring revenue.

One step up the ladder is sunk money subscriptions, where you sink money into a platform and then you buy information or something on a subscription basis. A good example of that would be the Bloomberg Terminal. Wall Street traders have the hardware, the physical computer, that sits on their desk that's called the Bloomberg Terminal. They also buy the information on a subscription basis, so it's kind of mashing together two of these concepts, not only sunk money consumables, but also buying on a subscription.

Auto renewal is the next rung up the ladder, where instead of having a start and a stop date to a subscription, it's in perpetuity. When you store documents, for example, with a document storage company, like iron mountain, that's in perpetuity. They keep the documents until you say send them back or shred them, and they just keep billing you on a continuing basis. That's auto renewal or evergreen.

The most valuable form of reoccurring revenue is contract revenue, where a customer is contractually obligated to buy from you into the future. That, of course, is the most rock solid form of reoccurring revenue.

To improve your score on this attribute, what you want to try to do is both walk up this hierarchy of recurring revenues. Think of it as a ladder, moving up the rungs on the ladder. If you've got subscription revenue today, think about if you could turn that into auto renewal subscription, or if you've got evergreen subscription, could you make those contracts?

Once you can climb up as high as you can, you really want to focus on the proportion of reoccurring revenue. The ideal is a 100%. very few businesses get there, but the higher proportion of reoccurring revenue and the higher up the ladder you go, the more valuable your company is going to be.”

John also delves a little deeper into this topic on his “Built to Sell Radio” podcast:

“In this episode, John MacInnes describes how his company, Print Audit, hit a crisis point when his largest customer, who accounted for two-thirds of Print Audit’s revenue, clawed back their monthly spend by 90%. ”

Listen in and find out how MacInnes pivoted his business to a subscription revenue model, and the surprising results he got.

So if you're a business owner who's planning ahead and considering ways to exit your business on your terms, I hope the information I provide in these articles will help you reach those goals.

If you would like to chat to me about this in person, feel free to book a slot in my calendar and we can discuss it further.

FREE Assessment:

If you want to see how you score in each of the "8 Key Drivers" right now, take 15-minutes to complete this survey and you'll get a comprehensive 25+ page report benchmarking your business against its peers, plus 49 tips on how to improve those 8 key areas.

Links to the other Key Drivers Of Company Value

1. Financial Performance - Your history of producing revenue and profit, combined with the professionalism of your record keeping.

2. Growth Potential - Your likelihood to grow your business in the future and at what rate.

3. Switzerland Structure (Key dependencies) - How dependent your business is on any one employee, customer or supplier.

4. Valuation Teeter-Totter (Cash flow) - Whether your business is a cash suck or a cash spigot.

6. Monopoly Control (Key differentiation) - How well differentiated your business is from competitors in your industry.

7. Customer Satisfaction - The likelihood that your existing customers will re-purchase from you and also refer you to people they know.

8. Hub and Spoke (Company structure, systems and processes) - How your business would perform if you were unexpectedly unable to work for a period of three months.