Sellability Driver 5 of 8: The Hierarchy of Recurring Revenue

This driver of the sellability explains that the more recurring the more valuable the business is. It discussed the 6 forms of hierarchy from bottom to top.

Video Transcript:

When a buyer comes in and buy your business they wanna understand how’s this business gonna continue when you, the owner leaves, and so the more recurring revenue you can have, the ore valuable it’s gonna be, and I found there are 6 different forms or recurring revenue, and buyers view each of the forms a little differently.

I’m gonna give you the six, I’ll start from the lowest valuable one and end with the most valuable ones in the eyes of an acquirer. The first of the six form of the recurring revenue is simple CONSUMABLES – so I’m a coffee drinker, I probably have 2 a day, so in the morning and usually after lunch I’ve gotta refill on coffee so it’s a simple consumables business. One step up the ladder is the SUNK MONEY CONSUMABLES – so you’ve seen this espresso coffee makers, where you got the machine and you buy the little capsules, that’s called the sunk money subscription because you’ve sunk money in the machine, you’re way likely to buy the capsules from the same company. Next one rung up the ladder is SUBSCRIPTION REVENUE, so if you’ve ever subscribed to a magazine you know about that. There’s a start date and an end date to your subscription, and the editors know that you are a subscriber for either a year or 2 in the future. It’s a form of recurring revenue. One step up the ladder is SUNK MONEY SUBSCRIPTIONS where you sink money into a platform and then you buy information or something on a subscription basis. A good example of that whould be the Bloomberg terminal. You know Wallstreet traders have the hardware, the physical computer that sits on their desks, that’s called the Bloomberg terminal. They also buy the information on a subscription basis. So, it’s kinda mashing together two of these concepts, not only sunk money consumables but also buying on a subscription. AUTO RENEWAL is the next up on the ladder where instead of having a start and a stop date to a subscription, it’s in perpetuity. So when you store documents for example, they keep the documents until you say send them back or shred them and they just keep billing you on continuum basis, that’s auto renewal, evergreen. The most valuable form of recurring revenue is CONTRACT REVENUE where a customer is contractually obligated to buy from you in the future, and that is the most rock solid form of recurring revenue.

So to improve your score on this attribute, what you wanna try to do is both walk up this hierarchy of recurring revenue, think of it as a ladder moving up the rungs of the ladder. So if you’ve got subscription revenue today think about if you can turn that into auto renewal subscription, or if you got evergreen subscription, could you make those contracts. Once you can climb up as high as you can, you really wanna think of the proportion of the recurring revenue, ideal is 100%, very few businesses get there, but the higher proportion of recurring revenue, and the higher you come up the ladder, the higher the value of your company.

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