You've spent years building a successful small business. As you begin to plan your exit strategy, you conduct a formal valuation and discover that your company isn't worth nearly as much as you hoped.
Now what? Is there anything you can do to increase the value of your business between now and the time you list your company in the business-for-sale marketplace?
Fortunately, there is plenty you can do to increase business value. And building recurring revenue streams is the perfect place to start.
How Recurring Revenue Increases Business Value
Recurring revenue makes small businesses more appealing to buyers. There's simply more interest in businesses that can demonstrate reliable revenue streams. And we're not just talking about small improvements. In some cases, recurring revenue can significantly increase the value and sale price of the business.
In the software industry, companies that can demonstrate recurring revenue for SaaS software average a 6x revenue multiple for valuation, compared to a 3x revenue multiple for software companies that sell perpetual licenses. Essentially, recurring revenue doubles the value of software companies.
Although the impact of recurring revenue varies by industry and business model, there are several reasons why buyers are willing to pay more for companies with established recurring revenue streams.
- Revenue and Cash Flow - Buyers can count on recurring revenue right out of the gate. With guaranteed cash flow in their corner, they sleep a little easier knowing that they can repay loans and meet other financial obligations.
- Predictability and Stability - Businesses with recurring revenue are more predictable than other business opportunities. Owners forecast revenue months in advance and create budgets with a higher degree of certainty.
- Reduced Risk and Growth Potential - Recurring revenue streams serve as a buffer for income fluctuations. As a result, these businesses are less risky and present more opportunities for growth, especially if the buyer believes she can grow recurring revenue in the future.
Types of Recurring Revenue Opportunities for Small Businesses
Nearly every small business has the potential to generate a recurring revenue stream. But these revenue opportunities aren't always obvious.
For example, SaaS software presents a tech company with an obvious recurring revenue opportunity. But what if you own a restaurant? Or a hardware store? How do you generate a recurring revenue stream from these kinds of businesses?
The key is to look at your company through your customers' eyes and identify the various ways in which they rely upon your business. Every transaction, every point of connection represents a possible recurring revenue stream. The trick is to determine the recurring revenue model - or models - that are right for your customer base.
- The Constant Supply Model
Some businesses are tailor-made for recurring revenue because they feature products that are consumed and need to be replaced or replenished at regular intervals. This model is appealing to customers because it's convenient. By participating in a subscription for a consumable product, the customer saves time and eliminates the risk of running out of a product that is important to them.
Although this model is an ideal fit for household items (e.g., the kinds of items Amazon sells with Dash buttons), it can also be useful for companies that sell supplies to other businesses.
- The Special Treatment Model
Everyone wants to feel special and many people are willing to commit to a subscription for the privilege. But the special treatment model of recurring revenue isn't just about ego. In some cases, participation in a plan or program moves customers to the front of the line for products or services that are critically important to them.
Let's say you own an HVAC business that specializes in the repair and maintenance of heating and cooling systems for retail stores. At various times of year, you are extremely busy and it can take up to 24 hours to respond to work orders. To generate recurring revenue, you could offer a service plan that guarantees a response within two hours, effectively moving customers who participate in the plan to the front of the line.
- The Service Contract Model
Service contracts are common in businesses that provide a valuable product or service. They are based on the idea that the company will provide a defined scope of services to program participants if the product they purchase needs to be repaired (e.g., copiers) or provide specific services at a certain frequency (e.g., building maintenance).
For customers, the benefit of a service contract is reduced risk. Instead of scrambling to find a repair provider for the copier or to meet building maintenance requirements, the customer commits to a service contract and receives an assurance that their service needs will be me for the duration of the contract.
- The Lease vs. Buy Model
Leasing is one of the world's oldest recurring revenue models. In today's economy, this form of recurring revenue can be generated by many different types of small businesses - not just providers of equipment, vehicles or real estate.
For example, technology companies routinely lease software or data storage. But if you own a more traditional small business, it may be possible to lease space or other assets that aren't in use during non-business hours.
For additional insight on creating recurring revenues, check out John Warrillow's book, The Automatic Customer: Creating a Subscription Business in Any Industry. The book provides a blueprint for winning automatic customers using one of nine different subscription business models.
When you develop a subscription program or other recurring revenue model, it's important to offer multiple price points. Instead of simply giving customers a yes or no choice, a tiered approach makes it easier for customers to identify a plan that meets their needs.
And that's important to keep in mind. Recurring revenue isn't only about padding your company's sales numbers. It's about meeting customers' needs in a way that strengthens their connection to the business, while increasing the value of the business to buyers for when you decide to exit down the road.