When a buyer comes in to buy your business they want understand, Okay, how’s this business gonna continue when you the owner leave. So the more recurring revenue you can have, the more valuable it’s going to be. I found that there really six different forms of recurring revenue. And buyers view each of the forms a little bit differently.
6 Types of Recurring Revenue
I’m going to give you the six types like the David Letterman’s top 10 list. I’ll start from the lowest value one and end with the most valuable ones in the eyes of an acquirer, the first of the six forms of reoccurring revenue is simple consumables. So I’m a coffee drinker. I probably have two a day so in the morning and usually after lunch, I’ve got a refill on coffee. So it’s a simple consumables business.
One step up the ladder is a sunk money consumable. So you’ve seen these Nespresso coffee makers, where you get the machine and then you buy the little capsules. That’s called the sunk money subscription because you’ve sunk money in the machine, you’re way more likely to buy the capsules from the same company.
Next one up the ladder is subscription revenue. So if you’ve ever subscribed to a magazine you know about that, right? There’s a start date and an end date to your subscription and the editors know that you’re a subscriber for either a year or two years into the future. It’s a form of reoccurring revenue.
One more 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 that would be the Bloomberg terminal. You know, Wall Street traders have the hardware the physical computer that sits on their desk, that’s called the Bloomberg terminal. They also buy the information on a subscription basis. So it’s kind of mashing together two of these concepts not only sunk money consumables, but also buying on a subscription.
Auto renewal is the next rung up the ladder where instead of having a start and a stop date to a subscription, it’s in perpetuity. So we use store documents for example, with a document storage company like Iron Mountain that’s in perpetuity, they you keep it keep the documents until you say you send them back or shred them, and they just keep billing you on a continuing basis. That’s auto renewal evergreen.
The most valuable form of reoccurring revenue is contract revenue, where a customer is contractually obligated to buy from you in the future, and that of course, is the most rock solid form of recurring revenue.
So to improve your score on this on this factor, what you want to try to do is walk up this hierarchy of recurring revenue, so think of it as moving up the rungs on the ladder. So if you’ve got subscription revenue today, think about if you could turn that into auto renewal subscription or if you’ve got evergreen subscription, could you make those contracts? Once you can climb up as high as you can, you really want to focus on the proportion of reoccurring revenue. The ideal is 100%. Very few businesses get there but the higher proportion of reoccurring revenue and the higher up the ladder you go, the more valuable your company’s going to
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