If you are considering selling your business, you will need to have a clear understanding of its type of customer revenue because it can significantly impact the value of your business. Sometimes people confuse recurring revenue with repeat revenue, but it is essential to understand how they are not the same thing.
Recurring revenue stems from a contractually bound legal agreement for a solution delivered over time. It is usually contractual over one or multiple years, and because it may carry penalties or fees if the customer leaves, it can be counted on into the future. This makes it highly valued by prospective acquirers because of its predictability and lower risk.
However, recurring revenue does not have to be contractual to be valuable. Depending on the business and the services offered, it can be too costly or too much of a hassle for a customer to leave or switch providers. An excellent example of this is customer relationship marketing companies that collect large amounts of valued data over time, making it more beneficial for clients to stick with their services. Below is a list of the different types of recurring revenue.
Memberships & Subscriptions: This is a no-brainer. Customers have to continue to pay for a product or service regularly if they have to become a member or subscribe.
Consumables: These are products that people use and regularly need, such as toilet paper, toothpaste, and soap. These items need to be replenished, and customers often tend to stick with their favorite brands.
Warranties: Warranties can also keep a customer for an extended period of time and they usually yield high profits because they are paying for something that may not ever be needed or used.
Contracts: Contracts are another way to lock the customers into an extended relationship with your company.
Service Fees: Offering maintenance or training on a product is a great way to get recurring customers and maintain a steady revenue stream.
Multiple Streams of Income: Try branching out into various revenue streams through vertical integration or buying other segments of the production line. Selling different yet similar products can grow revenue.
Repeat revenue typically happens regularly but is not contractually bound on a yearly or longer-term basis. However, there can be an invisible contract that occurs in some cases because replacing the service is either too expensive or time-consuming.
Recurring revenue is always more valuable than repeat revenue, but they can still be beneficial. You can increase the value of repeat revenue for a buyer by carefully tracking your customers, their satisfaction, and how long they have been with you. An acquirer can be more confident in the reliability of your repeat revenue if you can show them tangible proof that they are happy with your services, such as through customer satisfaction surveys and case studies. You should keep track of this regularly and look for trends that could be helpful indicators of how you can continually improve your level of service. This level of dedication will also prove to the buyer that you are serious about the quality of your company.
In either case, customer loyalty is a valuable commodity for any business. Did you know that loyal customers are worth 10 times as much as their initial purchase? And it can cost five times more to get new customers than it does to retain existing ones. A 5% increase in customer retention can boost a company's profitability by 75%. This is why your customer base is so crucial to your company valuation.
Metrics for Measuring Recurring Revenue
So, we know that recurring revenue is more valuable than repeat revenue. But how do you measure it? CFOs commonly use the following metric formulas to measure recurring revenue.
Customer Lifetime Value (CLV)
Formula: ((MT x AOA) AGM) ACR
MT = Number of Monthly Transactions
AOA = Average Order Amount
AGM = Average Gross Margin
ACR = Average Customer Retention (in Months)
Average Revenue Per User (ARPU)
Formula: Total Revenue/Total Subscribers
Churn and Retention Rates
Retention Rate: % of Customers Retained from Period to Period
Churn Rate: % of Customers Lost from Period to Period
Customer Lifetime Value to Customer Acquisition Cost (CLV-to-CAC) Ratio
CLV = See above
CAC = Total Sales & Marketing Costs/Total New Subscribers Added
Annual Recurring Billings (ARB)
Formula: The Sum of All Customers' Annual Subscriptions & Usage
Recurring Revenue Can Increase Value
When getting ready to enter into a merger or acquisition, one way to increase its value is to create a recurring customer base. While both repeat and regular customers are always better to have than one-time customers, it's the frequent customers that will be the most beneficial for your bottom line. This is because this source of revenue is the most stable and predictable, which buyers prefer, and gives you a competitive edge. If you can find ways to create a recurring customer base, your company will stand out, attract more buyers, drive up the value of the business, and cause it to be sold faster.
If you are interested in selling your business and would like to get a one-on-one valuation, check out our Virtual Valuation Workshops and schedule yours today.
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