Value Driver 5: Recurring Revenue
Value Driver 5: Recurring Revenue
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When a buyer comes in to buy a business they want to understand how this business going to continue when you, the owner, leaves. The more reoccurring revenue you have the more valuable it's going to be.
There are really six different forms of recurring revenue and buyers view each of the forms a little bit differently. Here are the six forms of recurring Revenue, kind of like a David Letterman's top ten list. I start from the lowest value one and end with the most valuable ones in the eyes and acquirer.
Consumables: The first of the six forms of recurring revenue is simply consumables. If you are a coffee drinker, you probably drink coffee daily, or even several times a day. You most likely also have a routine where you buy your coffee, and do this over and over.
Sunk Money Consumables: One step up the ladder is a sunk money consumables. You've seen these Nespresso coffee makers where you got the machine and then you buy the little capsules. That's called a sunk money subscription because you've sunk money in the machine. You're way more likely to buy the capsules from the same company.
Term Subscription. Next step up the ladder of subscription revenue is term subscription. 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 recurring revenue.
Sunk Money Subscriptions: 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: Auto Renewal is the next rung up the ladder where instead of having a start and a stop to a subscription it's in perpetuity. For example, when you store documents with a documents storage company like Iron Mountain that's in perpetuity. Iron Mountain keeps the documents until you say you want them to send them back or shred them. They just keep billing you on a continuing basis. That's what we call “evergreen subscription.”
Contract Revenue: The most valuable form of reoccurring revenues contract revenue, where a customer is contractually obligated to buy from you in the future. That of course is the most rock solid form of reoccurring revenue.
To improve your score on this Value Driver, what you want to do is to try to walk up this hierarchy of recurring revenues. Think of it as a ladder and you are trying to move up the rungs on the ladder. If you've got subscription revenue today think about it if you could turn that into auto renewal subscription. Or, if you've got Evergreen's subscription could you make those contracts?
Once you have climbed up as high as you can now you want to focus on the proportion of recurring revenue. The ideal would be 100 percent. Very few businesses get there but the higher proportion of recurring revenue and higher up the ladder you go the more valuable your company is going to be.
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