The math behind successful as-a-service series: business valuation

Posted:
04/09/2020
| By: Gregg Lalle

In the fourth (and final) part of our ‘The math behind as-a-service’ blog series, we’re diving into our last key performance indicator (KPI): business valuation. In this post, you’ll learn what it is, why it matters, how to calculate it, and how to increase it.

What is business valuation?

Business valuation, also known as revenue valuation, is an estimate of how much your business is worth. While the metric once focused almost exclusively on revenue, today’s calculations are increasingly complex—factoring in diverse billing methods and revenue models, which are often calculated at different rates. Ultimately, business valuation lets you (and the world) assess your company value.

Why does business valuation Mmatter?

Optimize your exit strategy

No matter how great your company is, you can’t run it forever—which is why business owners need strong exit strategies or plans to eventually pass on company ownership. Exit strategies include mergers, acquisitions, IPO, shutdown, and more. Whether you’re passing your business down to your kids or selling it to a new owner, it helps to proactively calculate business valuation—while increasing your company value as much as possible. Expanding practice areas and strengthening your stream of reliable revenue are two of many ways you can boost business valuation and cash in as you approach the time to exit.

Prime your business for mergers and acquisitions

For technology solution providers (TSPs), the mergers and acquisitions (M&A) market is booming, with valuations at an all-time high. Simply put, it’s a seller’s market for TSPs. Even if M&A isn’t currently on your radar, there are proactive steps you can take to ensure that your business is valued as highly as possible—when and if the time comes to sell.

  • Know your value inside and out. Buyers are looking for value, so you need to show them what your company is worth. By keeping a keen eye on your business valuation, you can proactively identify aspects of your business that make it valuable and aspects that don’t. To alter your business and optimize your value, you first need to be aware of it.
  • Consider a recurring revenue model. According to a recent study from Aria research, only 11% of businesses plan to rely on one-off sales as a major source of revenue moving forward. Increasingly, businesses in the as-a-service space are transitioning to the recurring revenue model, which enables service providers to rely on sustained revenue streams by investing in ongoing client relationships. A successful recurring revenue model tells potential buyers that you’re not only profitable but reliable—with money coming in consistently and predictably. By transitioning to a recurring revenue model, you can increase your valuation and instill confidence in potential M&A partners.
  • Put in work today to make yourself profitable tomorrow. Even if you think you’ll never sell, run your business as if you’re getting ready to. By strategically pricing your services, monitoring client behavior, and investing in client relationships, you can build a business that’s functional, profitable, and, should you ever choose to sell, extremely valuable.
How do you calculate business valuation?

Recurring revenue plays a major factor in business valuation. To calculate this KPI, use the following formula:

p(.12) + l(.16) + r(2.5)
p = product
l = labor
r = recurring revenue

How to improve business valuation

Invest in recurring revenue

One thing is clear from the business valuation formula: recurring revenue matters a lot. Stable and predictable, the recurring revenue model allows businesses to take control of their income and boost KPIs like customer lifetime value (CLV). TSPs with recurring revenue models aren’t just profitable; they’re also economically resilient—equipped to weather changing economic conditions.

These are just some of the benefits of switching to a recurring revenue model (or strengthening the one you already have):

  • Reliable revenue. With recurring revenue, you can depend on a steady stream of income, without scrambling to make large, sporadic sales.
  • Stable metrics. Given its consistency, recurring revenue allows you to compare and contrast important KPIs and metrics that can guide business strategy.
  • Sales opportunities. Since recurring revenue fosters loyal, long-term relationships with clients, it gives you the opportunity to increase profits by cross-selling and upselling to clients who know and trust your services.
  • Strong client relationships. Your client relationships are integral to a recurring revenue model, and by nurturing them, you’re able to stay aligned.

Maximize your profit margins

Changing the way you sell services can increase the money you bring in—and the satisfaction of your clients. To maximize your profits, and work towards a higher business valuation, consider a strategic transition to recurring revenue.

Businesses that use a recurring revenue model are worth 16 times more than those with a one-time revenue model, meaning they have higher business valuations (and all of the associated benefits). It’s estimated that owners of companies with a one-time sales model can expect to receive 4 to 6 times earnings before interest, taxes, depreciation, and amortization (EBITDA), whereas owners of companies with recurring revenue models can expect 6 to 8 times EBITDA.

Put simply, using a recurring revenue model can help you maximize your earnings, increase your profit margins, and, ultimately, skyrocket your company valuation.

Master other key performance indicators by reading the rest of our ‘The Math Behind As-a-Service.’ Discover insights on churn, customer acquisition cost (CAC), and customer lifetime value (CLV) that you can bring back to your business today.

Recommended