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 must start from scratch each month, the value of your company will be lower than if you can pinpoint the source of your future revenue.
A recurring revenue stream acts like a powerful pair of binoculars for you to see months – even years – into the future, so creating an annuity stream is the best way to increase the value of your business.
Watch this video in which John Warrillow explains the six forms of recurring revenue.
There are various forms of recurring revenue. The surer your future revenue is, the higher the value the market will place on your business. The list below outlines six forms of recurring revenue presented from least to most valuable in the eyes of an acquirer:
No. 6: Consumables (e.g. toothpaste)
Consumables are disposable items like shampoo and toothpaste that customers purchase regularly but that they have no solid motivation to repurchase or to be brandloyal to.
No. 5: Sunk-money consumables (e.g. razor blades)
More valuable than a straightforward consumables business is one centered around ‘sunk-money consumables’. The customer first makes an investment in a ‘platform’. For example, once you buy a razor, you have sunk money into a platform and have a vested interest in buying the compatible blades going forward.
No. 4: Renewable subscriptions (e.g. magazines)
Even better than having loyal customers who repurchase is having revenue that is guaranteed into the future in the form of a subscription. Typically, subscriptions are paid for in advance, making them an excellent way to create a positive cash-flow cycle and wean your business off a reliance on bank financing.
No. 3: Sunk-money renewable subscriptions (e.g. the Bloomberg Terminal)
Traders and money managers swear by their Bloomberg Terminal. Bloomberg customers have to first buy or lease the terminal and then subscribe to Bloomberg´s financial information. Having sticky customers loyal to a proprietary platform allowed Michael Bloomberg to build a valuable company.
No. 2: Automatic-renewal subscriptions (e.g. document storage)
When you store documents with a document storage company, you are charged a fee each month until you decide to pick up your documents. Unlike a magazine subscription, for which you have to make the conscious decision to subscribe each year, the company just bills you until you tell it to stop.
No. 1: Contracts (e.g. mobile phones)
The only thing more valuable than an automatic-renewal subscription is a hard contract for a defined term. As much as we may despise being tied to them, mobile phone companies have mastered the art of recurring revenue. Many give customers free phones as long as the customer locks into a two- or three-year full-service contract.
Think of the list above like a ladder. Each rung you climb on the way toward number one, the more valuable your business will be.
Consider the following questions with your Business Doctor:
How could you move up the hierarchy of recurring revenue?
Could you add a consumable element to what you sell?
What benefits would you have to offer customers to get them to buy from you for a year in advance?
How could you get customers to sign a long-term contract with your business?
Would some of your customers prefer to be billed automatically rather than manually submitting a regular payment?
Could you offer a maintenance contract to service what you sell?
What is the next step?
There are 8 factors that drive that value of a business.
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