So after reading about our writeup on the Value of the PSL, a dear friend pointed us towards this lovely tidbit: a woman in Illinois recently purchased a full year’s supply of pumpkin spice latte fixins’. Can you imagine? And entire year of pumpkin spice? (For our money we’d work on being seasonally appropriate. PSL is NOT for spring mornings.)
In any case, this got us thinking: beyond pure earnings, what is the number one item that has a positive impact on valuation? Recurring revenues. Look at any business model or industry that is built around a recurring revenue stream and you will see higher relative valuations. Examples:
- Home security monitoring (monthly contracts)
- Government contractors (multi-year contracts)
- Insurance agencies and brokers (low defection rates of clients)
So why the premium for recurring revenues? Simple. It diversifies / hedges against risk. Investors pay premiums for businesses with lower risk profiles. By purchasing a business that has a highly identifiable, repeatable revenue stream an investor has (more) surety of what’s likely to happen post closing.
So how to build value in your business? We said it before: recurring revenues improve valuation. Focus on identifying and cultivating recurring revenues for your company.