The Hierarchy of Recurring Revenue: How to Make Your Company Irresistible to Potential Buyers

One of the biggest factors in determining the value of your company is the extent to which an acquirer can see where your sales will come from in the future. If you’re in a business that starts from scratch each month, the value of your company will be lower than if you can demonstrate the source or sources of your future revenue.? A recurring revenue stream acts like a powerful pair of binoculars for you – and your potential acquirer – to see months or years into the future; creating an annuity stream is the best way to increase the desirability and value of your company.

The surer your future revenue is, the higher the value the market will place on your business. Here is the hierarchy of recurring revenue presented from least to most valuable in the eyes of an acquirer.

No. 6: Consumables (e.g., Shampoo, Toothpaste)

Consumables are everyday items that customers purchase regularly. While they provide steady income, the challenge lies in brand loyalty. Customers may switch brands based on price or convenience, reducing predictability. To maximize the value of consumables, companies can focus on creating strong brand loyalty and unique value propositions.

No. 5: Sunk-Money Consumables (e.g., DSC Razor Blades)

Sunk-money consumables offer a step up in value due to the initial investment customers make in a compatible platform. For example, when customers subscribe to Dollar Shave Club, they receive a razor handle and then continue to purchase replacement blades. This creates a more predictable revenue stream as the initial investment in the razor handle encourages customers to buy compatible blades regularly, leveraging brand loyalty and convenience.

No. 4: Renewable Subscriptions (e.g., Magazines)

Renewable subscriptions generate recurring revenue through advance payments. This model creates a positive cash flow cycle, as customers pay upfront for the service. The predictability of renewals can be increased through strategies like automatic renewals, discounts for long-term commitments and high-quality content or services that keep subscribers engaged.

No. 3: Sunk-Money Renewable Subscriptions (e.g., Keurig K-Cups)

In this model, customers make a significant initial investment in a product or platform, followed by ongoing subscription payments. Keurig K-cups provide a clear example of this model. After purchasing a Keurig or similar coffee maker, customers need to buy compatible K-cups to use the machine. This creates a recurring revenue stream as customers regularly purchase K-cups to continue enjoying their coffee, making it a highly attractive model for acquirers due to the dual commitment of initial investment and ongoing purchases.

No. 2: Automatic-Renewal Subscriptions (e.g., Google Data Storage)

Automatic-renewal subscriptions provide one of the most predictable forms of recurring revenue. Services like Google data storage charge customers monthly without requiring manual renewal, leading to a steady and reliable income stream. The convenience and inertia associated with automatic renewals make this model highly attractive to acquirers.

No. 1: Contracts (e.g., Cell Phones)

Contracts represent the highest level of recurring revenue value. Cellular companies, for example, often provide free or discounted phones in exchange for long-term service contracts. These contracts ensure a stable revenue stream over several years. The binding nature of contracts significantly reduces churn and guarantees income, making this model exceptionally appealing to potential buyers.

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When you put your business up for sale, you’re selling the future, not just the present. If you don’t have a recurring revenue stream, consider how best to create one, given your type of business. It will increase the predictability of your revenue, the value of your business, and the interest of potential acquirers as they look to the future. Establishing a robust recurring revenue model not only secures financial stability but also enhances the overall attractiveness and market value of your business.

If you’re curious to see?the value of your company, take?the Value Builder questionnaire, a short 35 questions that allows us to place an estimated value on your company.

Book A Free Consultation with The Greenhouse and find out how we can help you build greater value in your business through The Value Builder System?.