Want to Raise Capital? You Need a Recurring Revenue Strategy

gigcmo
23/03/2021

If you plan on raising capital or intend to exit your company in the foreseeable future, you must have a recurring revenue strategy. Why? Because it's one of the biggest influencers determining the multiples of value, a.k.a - what the company's worth.

In recent weeks we discussed how companies make money and how that can change and evolve with a marketing expert providing independent advice. For those who want to grow their company faster by raising capital or create an exit pathway (vital for investors) over a set period, then the second half of that question is 'what is your company worth?'. 

The 'what' is intrinsically tied to the 'how' - how does the market calculate valuation? This is simply connected to how much revenue your business model generates, but what investors also want to know is how repeatable and recurring  that revenue is.

What is recurring revenue?

Investopedia describes recurring revenue as: 

"The portion of a company's revenue that is expected to continue in the future. Unlike one-off sales, these revenues are predictable, stable and can be counted on to occur at regular intervals going forward with a relatively high degree of certainty."

Fractional Chief Marketing Officer and CEO Whisperer, Michael O'Hara, says he thinks of it in terms of "how much business will you do if you turn off the proverbial lights?" That is to say - if you stopped doing any new business tomorrow, how much money would you make and for how long? It is another reason to get your pricing strategy right from the get-go.

How do you value a company against recurring revenue?

Typically, and obviously, other variables related to it as well, a valuation formula would see a company's market value as 3x to 5x its annual profits. When that revenue is recurring, it's considered much more stable than that based on new sales alone, which is logical, especially if that revenue is contracted in place. 

While a contract is in place, the emphasis shifts from sales and marketing to customer care and reduces or redirects the resources required for acquiring new business. When it comes to renewal, there is already a valuable relationship in place. It's likely that if the product and service have met customer expectations, then the client will renew the contract. 

Other factors in securing recurring revenue and its value to buyers or investors

Having recurring revenue as a contracted commitment is an excellent way to determine a company's turnover and, consequently, prove its value to buyers and investors. However, taking that a step further is the contract length. Typically, contracts in areas such as technology services have been one year in length. Still, businesses like Salesforce have broken that barrier and tied clients into two-year contracts, which, if we return to our Fractional CMO’s 'lights off' theory, has obvious appeal to investors when raising capital.

However, contractual commitment isn't everything. There are numerous examples of very effective business models that leverage the lifetime value of a customer. Amongst the earliest would be the likes of HP printers and disposal razor blades. In these scenarios, the company typically sells the initial printer or razor at cost, knowing that the printer won't work without their ink or that the razor needs to have the blades replaced (often on a subscription model) regularly. The initial product purchase may not generate much revenue (say £100 for the printer). However, the customer's lifetime value over a set period is projected to be significantly more (say £1000) through the recurring revenue. 

Another critical factor is product or service 'stickiness'.  How high is the hassle factor in switching away from your product or service once a customer is  using it? For example, once you have all your information in your accounting software, how much of a nuisance is it to change it, learn a new programme, get clients to interact with a new programme, and what are the chances of losing your data in the process? As creatures of habit, many of us are resistant to change when we're used to something, even if we know there's a better option out there.

For businesses to grow, it is common to seek out capital investment, but much like a mortgage, lenders or investors need to have a strong rationale and a clear exit strategy. Essentially, who would buy it and why at the end of a set period? Setting a value for your business is a crucial part of that. While it's not the only way to arrive at and justify a company's worth, the annuitisation of a product or service is a dependable, logical and respected way of giving others confidence in your business. 

If you would like to discuss recurring revenue strategies or the process of raising capital to grow your business, contact us any time.

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