recurring revenue - Investment Grade Advisory

Duane Donner 20, Jul, 2021

General

Not All Revenue Is Valued Equally

Most companies are valued by applying a multiple to the businesses EBITDA (earnings before interest taxes, depreciation, and amortization). However, buyers will closely examine the revenue streams generating that EBITDA and assess the quality thereof. Here are a few things buyers will look for when assessing a company’s revenue streams.

1. Revenue Consistency

The more stable and predictable the revenue stream and the profit therefrom, the more the buyer will be willing to pay. This provides forward visibility and mitigates risk, because the revenue can be counted on in the future with a high degree of certainty. Most subscription models would fall into this category. Assuming customer churn is low, and the lifetime value of the customer outweighs the customer acquisition costs, buyers will pay up for this type of business model. On the flip side, earnings generated from project based work or one-time events will typically be heavily discounted.

2. Customer Diversity

One strong customer can get a business up and going, but diversity is required to mitigate risk. This also applies to customer concentration within revenue streams. If the revenue stream would suffer meaningfully due to the loss of one or two customers, buyers will take this into account. Customer concentration will not only lower the value of a company but might scare off buyers altogether.

3. Margins

Buyers will pay great attention to a company’s margins and assess the overall business by comparing margins to like companies. Superior margins oftentimes mean a competitive advantage, which gives a buyer greater comfort that the revenue and profit therefrom is protected. In addition to looking at a company’s overall margins, buyers will assess the margin contributed by each revenue stream. Growth in revenue streams with higher margins will be rewarded, while revenue with lower margins, even if growing, will often be discounted.

Conclusion

These are important factors to consider when operating and growing your business. Yet, every company and industry is different and not every business model can have the recurring revenue and customer diversification of Netflix. If you want to know how you measure up in these areas, benchmark yourself against competitors or companies with a business model similar to your own. Taking action to improve and be the best among your peers in these areas will not only increase the value of your company, it will mitigate the risk you have as an owner.

Joseph Vinar 30, Jun, 2021

General

Home Services Businesses with Recurring Revenue Are More Valuable

Every business owner is asking, “What’s my company worth?” and “How do I increase its value?” As the adage goes, it’s worth whatever someone is willing to pay, so it’s helpful to view a company through the eyes of a potential buyer. Buyers pay for risk adjusted future cash flows. The two main ways to increase the value of your business are through increasing the future cash flows or by decreasing the risk associated with the cash flows.

Home services have traditionally received lower valuations due to riskiness of returns stemming from mostly one-time revenue. For example, a maintenance plumbing business does not know at the beginning of each month how many people will be calling with broken toilets and faucets. Perhaps a better plumber comes to town one month; suddenly a business that has been thriving for years could go under. The uncertainty of these revenues creates significant risks for investors.

Home services is strategically positioned to transition their operating models to generate recurring revenue. Recurring revenue is revenue coming from an ongoing contract or subscription. We’re seeing this with pest control companies which charge a monthly subscription fee for regular spraying. Plumbing companies are charging a fixed monthly rate for any plumbing issue to be rapidly resolved. These offerings provide peace of mind to the consumer and consistent cash flows to the business owner.

Transitioning revenue from one-time to recurring can significantly increase valuations. Even if an owner doesn’t want to sell their company for years, this shift towards recurring revenue meaningfully decreases risk and improves business fundamentals.