Selling the Recurring vs. the Non-Recurring Revenue Business
Whether starting a small business out of your garage or running a company that sells thousands of products per day, revenue is key. The ability to use assets and know-how to turn your investments into actual dollars is the sign of a healthy business – and one that investors quickly turn towards while assessing the value of a company. Many times, during the diligence stage of an acquisition, investors both strategic and financial (private equity), will investigate a key distinction between types of revenue: recurring and non-recurring.
Are recurring and non-recurring revenue valued differently?
They are! Recurring revenue is more valuable than one-time revenue. Sometimes, it is difficult for sellers to understand this concept. Oftentimes, we hear, “I just won [insert name of a big job] and my business is very valuable right now!” and to some extent that is true because it proves that your company is capable of performing the work and it may have enabled you to buy equipment or hire talented people. But one-time jobs are not going to be valued the same way repeat business is during an acquisition.
Certainly in the technology sector, recurring revenues are the gold standard. Converting customers to subscription-based contracts where the threat of renewals is mitigated can increase the value of a company overnight.
Let’s define recurring vs non-recurring (one-time) revenue?
Recurring revenue is the cash that a company can rely on receiving on a regular basis and generally comes in the form of service agreements, subscriptions, or a demonstrated ability to generate repeat customers in a predictable fashion (this last bit can be a bit squishy).
Think about any streaming service like Netflix or an internet service provider like AT&T; as their customer, you have an ongoing commitment to pay them for their ongoing services or access to products. This ongoing stream of business is considered recurring revenue. Importantly, the company has already won the business and it remains ongoing, indefinitely, and with a high degree of confidence. Recurring revenue is attractive to buyers because it provides a stable and predictable cash flow, making the business more valuable as it can be relied on to continue generating revenue post-sale.
It makes sense on the surface; a business that is more predictable is lower risk, therefore the expected return from an investor should be lower. Further, a buyer does not need to be compensated for the riskiness of the business in the form of a lower purchase price, as the likelihood of the expected outcome is more predictable.
On the other hand, non-recurring revenue is the cash that a company receives from individual transactions, such as the sale of a product or a one-time service. An example of this type of business could be a sofa store or homebuilder; you find one when you need it, make a purchase, and call it a day.
One-time revenue is less predictable and can be affected by factors such as seasonality, market conditions, and competition. Buyers may be less interested in businesses with one-time revenue models as they can’t rely on this revenue stream to continue post-sale. However, businesses with one-time revenue can still be valuable if they have a strong brand, intellectual property, or customer base.
What about the messy in-between businesses?
At a high level this all seems very straight forward, but to professional investors, there are many ways to slice and dice a revenue stream that might not seem so obvious.
There are many companies that have what could be considered non-recurring, non-contractual revenues that deliver steadily and grow nicely year after year. These businesses have the characteristics of a recurring revenue business but without anything guaranteed. Perhaps they have excellent customer relationships and have built a strong niche business. There are other ways to maintain a steady revenue stream.
There are also many hybrid companies. What if your recurring business is very low margin and takes a lot of investment to achieve but you have non-recurring, high margin business to generate profits? While just one example, addressing these value factors ahead of time is one of the many inputs that a professional advisor can help a business owner navigate ahead of a sale.
The trick is to remember that both recurring and non-recurring business models exist for a reason (investment banking is a non-recurring business model…). Recurring businesses tend to seem sexier and get bigger valuations in a sale process, but non-recurring companies can be higher margin, have lower investment to grow quickly, and generate meaningful revenues during their lifetimes. The point is not that recurring revenue models are better or non-recurring models are unsaleable. They are just different and there is a place for both of them.