Does recurring revenue make a business more valuable?

Why do buyers value recurring revenue?

A buyer is paying today for earnings that will arrive over the coming years. The more confident they can be about those earnings, the less risk they carry. Recurring revenue helps in three ways:

• Predictability: next year's revenue is partly known in advance, so forecasts are easier to believe.
• Lower cost of winning sales: less effort goes into replacing revenue each year.
• Resilience: a business with a base of recurring revenue usually weathers a weaker period better than one that depends on new orders.

Not all recurring revenue is the same

From most to least secure, broadly:

1. Contracted, recurring revenue: subscriptions, maintenance or service agreements with defined terms.
2. Retainers and framework agreements: ongoing arrangements that may be easier to end, or that fix terms but not volumes.
3. Repeat custom without a contract: customers who buy regularly by habit or preference, but are free to stop.
4. One-off work from repeat customers: projects for familiar customers, each one won separately.

All four can be valuable. A buyer will simply place more confidence in the first than the last, and will want evidence for whichever applies.

How do buyers test it?

A buyer's due diligence asks whether the revenue really recurs, and on what terms:

• Retention: how many customers renew or continue each year, and how much revenue is lost through customers leaving.
• Contracts: length, notice periods, renewal terms, price-review clauses and any change-of-control provisions. Your legal advisers can review these.
• Margins: whether the recurring work is profitable, or priced low to win it.
• Concentration: whether the recurring base depends on a few large customers.
• Who holds the relationships: the business, or the owner personally.
• Trend: whether the recurring base is growing, stable or shrinking.

What are the common pitfalls?

• Calling revenue recurring without evidence. A label without contracts, retention data or a track record will be tested and may be discounted.
• Recurring but unprofitable. Low-margin recurring work adds less to value than its revenue suggests.
• Recurring but dependent on the owner. If customers renew because of their relationship with the owner, a buyer will ask what happens after the sale.
• Recurring but concentrated. A large recurring contract with a single customer brings its own risk.
• Recent conversions with no track record. Moving customers onto agreements shortly before a sale helps, but a buyer will usually give more weight to arrangements with an established renewal history.

How can owners increase recurring revenue?

Where it suits customers, owners can:

• move regular work onto written agreements with clear terms;
• offer service, maintenance or support arrangements alongside one-off sales;
• review pricing so recurring work is properly profitable;
• track retention and renewal each year, so the evidence exists when a buyer asks.

As with other value drivers, the changes carry more weight when they have an established track record before a sale.

What this means in practice

Divide last year's revenue into the four categories above, and record retention for the recurring parts. If most revenue sits in the first two categories, with good retention and margins, that is a strength to evidence. If most sits in the last two, that is an area to work on before a sale.

Our complete guide to valuing a small UK business explains how revenue quality fits alongside the other value drivers.

How Proplexo can help

Our Strategic Valuation Review is a practical valuation focused on both current value and what could improve it, including the key value drivers and the concerns a buyer is likely to raise.

This article is general information for owner-managed businesses, not advice on your circumstances.