So we know that recurring revenue will make your business more valuable. What we’ve seen is that acquirers, when they value recurring revenue, look at it and place a different value on it depending on the type of recurring revenue you have – the contractual relationship that you have with your customers that buy from you on a recurring basis. This affects the value that acquirers will place on it.
There are 6 different contract types and now we’ll go through them so you can get a sense of which ones are most valuable. We’ll start with #6 (least valuable) and go to #1 (most valuable).
6 different contract types:
The consumable recurring revenue model states that the customer buys from you on some regular cadence because they run out of whatever it is you sell. A classic example is coffee. Coffee addicts (I am certainly one) have to replenish their caffeine high, and because of that, we have to replenish our supply on a regular basis. In this model, there is nothing specifically tying you to any particular coffee brand for a certain amount of time.
Staying with the coffee theme, the best example here is probably Nespresso. Here, customers make a purchase in a piece of hardware – they buy the physical coffee maker. This makes them much more likely to buy the capsules that Nespresso makes. Now Nestle, the owner of Nespresso, is a smart company. They make the machines that brew the coffee available in a wide variety of distribution channels – you can get them at a big-box retailer like Target, you can get them online from a lot of different stores. What they don’t do is make the Nespresso pods available so widely. What Nestle wants is the platform, the coffee maker, distributed as widely as possible, but they really want the direct recurring revenue of the capsules. So the only place you can go buy the capsules is through a Nespresso-branded retail store, or online at Nespresso.com. because again their value in this particular business model is in the recurring revenue of the capsules.
If you have ever subscribed to a magazine in your life, you know what a subscription looks like. typically there is a start date, but then there is also an end date to your typical subscription where you have to make the re-up decision.
This is kind of a mash-up of two types above. “Sunk-money” means the customer makes an investment in a platform. Then they buy on subscription.
A good example of that would be the Bloomberg terminal where Wall Street traders buy the physical hardware that sits on their desk, so they have sunk money into a platform, and then they buy Bloomberg’s information on a recurring basis, so they are much stickier of a subscriber. This is because if they are going to give up their subscription to Bloomberg, the big piece of hardware that is sitting on their desk is no longer valuable. SO it makes them even stickier, and therefore more valuable in the eyes of an acquirer.
This one is very similar to #4, subscriptions, but the only real difference is there is no formal renewal date. These are much more valuable forms of subscriptions to acquirers because there is no end date and therefore the revenue goes on into the future until the customer cancels.
A good example of an auto-renewal subscription would be any software that you have bought in the last few years is typically on a recurring evergreen model. In the offline world, you can look at a business like Iron Mountain which will store documents for you. They don’t call you up every month and say “would you like us to continue to store the documents?” They just store the documents for you on a forever basis. You have to either call them and tell them to ship them back or shred them. Otherwise, they are going to bill you and continue to store your documents. That is an Auto-Renewal Subscription.
The most valuable form of subscription in the eyes of an acquirer is a multi-year contract where the contract stipulates the customer must continue to buy from you.
For example, when most wireless carriers launched the iPhone, the iPhone was such a desirable product. There was so much hype that the wireless providers forced their customers into a 3-year contract that they couldn’t get out of because they knew customers would be willing to buy it. They also knew their stock price in return would be based on this contract value. This is going to be the most valuable type of recurring revenue. If you can get multi-year contracts from your customers, then an acquirer will see that that revenue is guaranteed beyond your tenure as the owner.
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