How to buy a business with recurring revenue for sale
March 20, 2023 ⋅ 10 min read
If you’re like the thousands of buyers that we interface with, you may be looking for businesses that generate recurring revenue. We wanted to break down what that means, how to create recurring revenue, and how it affects the sales process.
Here’s a guide to understanding recurring revenue and the steps to buying a business with recurring revenue.
What is a recurring revenue business model?
Recurring revenue in a business model is when the revenue is regular, stable, and likely to continue into the future. As opposed to the one-time business model, in which a customer purchases a product and then typically won’t buy again, the recurring revenue stream allows businesses to generate consistent recurring revenues by giving customers continued access to a product or service in exchange for a regular monthly recurring fee charged at scheduled intervals — like monthly or annually.
Since customers are consistently purchasing the service or product, it creates regular cash flow, and oftentimes, a sustainable and great business model for the company. A company that has a recurring revenue business model typically has less risk and is more attractive to potential buyers than other types of business models.
There are a few different aspects of recurring revenue streams. New business recurring revenue is revenue earned from new customers onboarded onto your product or service. Expansion recurring revenue is additional revenue earned from existing customers in the form of add-ons or cross-sales.
What are examples of a recurring revenue model?
Here are some of the common types of recurring revenue business models:
Service is provided over a set period of time for a set amount of money (ex. Mobile phone contracts).
Sunk money consumables:
A customer initially buys a service or product and then makes recurring purchases to continue using that product (ex. Razors or Keurig cups).
A user is subscribed until they voluntarily cancel their subscription. This can take the shape of routine services such as ongoing access to an online membership site or a membership program like a subscription box.
What businesses have monthly recurring revenue?
Here are some of the other business types that typically have monthly recurring revenue.
Home Service Businesses
Many service businesses have monthly recurring revenue. For example, home service businesses such as lawn care, pool maintenance, and housekeeping typically charge a monthly fee. This provides the business with a predictable stream of income and allows the customer to budget for the service.
Memberships or Private Clubs
Businesses that have monthly recurring revenue are subscription or membership models — like Netflix or Amazon Prime. These companies are built on repeat customers who pay a monthly fee or annual fee in exchange for access to the product or service. Membership companies typically focus on building an engaged community of users who interact with each other or the brand.
There are also businesses that charge a recurring fee simply for access or networking. This includes gyms, professional organizations, and nonprofits. The benefits of using a membership model are the ability to predict and have stable cash flow, lowered marketing costs, and additional opportunities to cross-sell members down the line.
Membership websites are a way for companies to offer digital access for a fee, helping to build an online community and drive online revenue.
Physical product subscriptions
As the name suggests, physical product subscriptions offer a regular tangible product for a recurring price. A common version of this is the “box subscription” model (examples include the Dollar Shave Club or Birchbox).
Because this subscription involves physical products, there are more logistical factors involved and typically more costs, including the cost to deliver the product or source the materials.
Software as a service (SaaS)
Even business-to-business companies can utilize a recurring revenue business model. Some software companies offer access to their technology or service on a subscription basis instead of a one-time sale. Known as SaaS, these companies cut down on the initial high cost of setting up software and make it more seamless to implement product updates.
What’s more, SaaS businesses make it possible for software developers to deliver product updates more easily. An example of a successful SaaS business is Adobe.
Services or Retainers
Most companies that offer a service may be able to turn their business model into a revenue business model, by offering their service up to regular renewal instead of a one-off purchase. This includes consulting agencies, IT services, insurance agencies, and more.
This way, companies can receive recurring income by putting customers repeatedly through the sales cycle and making it possible to cross-sell to them later down the road.
Freelancers or contractors will often offer their services for a retainer fee, or a regular payment in exchange for a set of services or products. For example, if you’re a freelance writer, you could offer a monthly fee in exchange for a set amount of blog posts or social media posts.
What are the best cash flow businesses?
Some of the best cash flow businesses are ones that take some upfront work, but then typically run themselves, allowing the company owner to earn passive income from it once the initial investment is complete. We mentioned SaaS companies and subscription-based companies before, but other examples of the best cash flow businesses include:
Home & building services (including landscaping, cleaning, or property management)
Healthcare & medical companies
Education (preschools and daycares)
How do you value a recurring revenue business?
Business valuations are important to understand a company’s financial health — it’s especially helpful if you’re considering selling your business and want to know how to price your company. There are many different ways to value a business, and much of it is dependent on the size of the company and the industry it’s in.
When valuing a business, there are a few key things you need to take into account:
The business’s revenue
This is perhaps the most important factor in determining a business’s value. Revenue can be divided into two categories: one-time and recurring. One-time revenue is generated from one-time sales, such as selling a product or service. Recurring revenue, on the other hand, comes from customers who regularly purchase from the business on a subscription basis. When valuing a business, it’s important to consider both types of revenue.
The business’s expenses
In order to determine a business’s value, you need to subtract its expenses from its revenue. This will give you the business’s net income.
The business’s growth potential
A business that is growing rapidly will be worth more than a business that is not growing. When valuing a business, it’s important to consider its growth potential.
By taking all of these factors into account, you can get a good idea of how to value your business. If you’re thinking of selling your business, it’s important to get an accurate valuation so you can price your company correctly. But, one of the most important things to understand is that businesses with recurring revenue are more valuable than those with non-recurring revenue. Discover our guide to the common business valuation approaches to learn more.
How does this differ from non-recurring revenue businesses for sale?
Typically, a company with a recurring revenue model will be more valuable than one that has a one-off product or service model. While it’s not always guaranteed that the recurring revenue is expected to continue into the future, it’s more likely that it will over a business that has a one-off business model. These types of companies also tend to do well during market downturns.
If a portion of a company’s revenue is determined from transactional or one-off sales, buyers will often require a higher rate of return.
How much can you sell a business for based on revenue?
Business valuation is a complex process, and there is no simple answer to the question of how much a business is worth. However, revenue is one of the most important factors that appraisers take into consideration when determining how much to sell a business for. In general, businesses with higher revenue are worth more than those with lower revenue.
This is because businesses with higher revenue have the potential to generate more profit and therefore represent a greater investment for buyers. However, there are many other factors that can affect the value of a business, such as its growth potential, profitability, and sector.
One way to value your business based on its revenue is by using the seller's discretionary earnings (SDE) method, which is utilized exclusively by small businesses and is often the choice method when buying or selling a small business. The seller’s discretionary earnings method can help a buyer to understand how much income they can reasonably expect to earn from the business. This method involves determining the business's earnings before interest, taxes, depreciation, or amortization. This information, known as net profit, is found in your company's financial statements.
Most businesses will sell for two to four times the seller’s discretionary earnings. For example, if your company’s annual cash flow is $100,000, your selling price will likely be around $200,000 to $400,000.
A way to value your business based on its revenue is by comparing your current revenue and profits with what has occurred in the past. It’s important to consider how much income your company is expected to generate, what your company owns (its assets), and how much the market is likely to pay for the business based on comparable sales.
Why do investors prefer recurring revenue?
Companies with recurring revenue typically have more predictable revenues, which makes them less risky from an investment standpoint. Businesses with recurring revenue models also usually have more money on hand, which can make them more attractive to potential buyers.
Lastly, companies with recurring revenue are often seen as being more stable and predictable than businesses without recurring revenue. As a result, investors tend to prefer companies that have a recurring revenue model.
Benefits of recurring revenue business model
There are many benefits for a business to have a recurring revenue model:
One of the most essential benefits of recurring revenue is that it provides small businesses with the ability to accurately predict their future income since they can look back at their recurring income. Having regular recurring revenue helps build strong relationships and trust among investors and makes it easier to value your business.
With recurring revenue business models, companies can easily measure their future growth rates and forecast future expansion.
Making repeated sales to existing customers is simpler and more cost-effective than acquiring entirely new customers who don’t have a relationship with your service or product.
Since it accurately predicts future income, recurring revenue represents the financial stability of your small business.
How Baton can help
Understanding how recurring revenue business models work can help you find the right small business to buy and help you get an accurate picture of how much a business is really worth. The valuation experts at Baton are happy to help you with the entire process.
At Baton, we leverage a combination of valuation approaches to determine the accurate value of a recurring revenue business. Our goal is to provide quality business valuations and appraisals to help you make sound buying decisions. Find the right business, get a valuation today, and connect with a Baton business advisor. If you have further questions regarding business valuation, you can learn more today.