Investors simply like high quality revenue, that is it :)…
In business valuation, high quality revenue—the kind of earnings that investors seek—is defined by three essential characteristics: Predictability, Profitability, and Diversity.
Predictability is the most important, so we will take about it the last.
It defines what is your gross margin, which is (net sales – net cost). investors usually likes business that generates gross margin of 70% and more !!!
When we evaluate companies we look closely at revenue concentration. Investors do not like a business with main revenue stream coming from one product or one customer. It could be accepted for a company in its early stages, but they should have a plan on how to diversify their revenue stream.
This the most critical and important factor, we can define it by the following sentences:
- How many paying customers you have from the last year.
- How much cash you can confirm that you going to earn this year or the next year.
- how many customers you lose each year.
Investors look for the bushiness with recurring revenue.
As an example, if you are in the IT business and have a cloud application where each customer pay 100$ per month. You are at the end of 2014 with 100 customers. You usually lose 10% of your customers each year (churn rate), then we can easily predict that you going to have recurring revenue of 9000$ per month during the next year. If you know your growth rate just like you know your churn rate, then this will be better.
You can count on recurring revenue month over month and year over year. Cash flow is steady and improving all the time. You don’t have to stress about payroll and other expenses, so you can put your energy toward more strategic business-building activities. Having a steady income stream liberates you to take risks and get more aggressive with your business plan. Move into a new market. Go after larger, harder-to-land clients. If you miss a sales target one month, your cash flow remains unaffected.
Recurring revenue builds a valuable legacy for whenever you decide to exit your business. Increasing the amount of monthly recurring revenue coming into your business raises the quality of your earnings and the overall value of your business.
Some professionals estimate that a business with recurring revenue is worth 16 times more than a one-time revenue model (such as rip and replace). Another recent article estimated that an owner can expect to receive 4 to 6 times EBITDA [earnings before interest, taxes, depreciation, and amortization] for a company on a one-time sales model, while owners with recurring revenue can expect a payday of 6 to 8 times EBITDA
Focus on growth and growth alone is always a temporary strategy. Over time, a company’s value becomes a function of both growth and cash flow. Superior earnings eventually lead to superior value creation.
It’s a simple enough framework, but often difficult to achieve. High-quality revenue requires predictability, profitability and diversity. Do you have highly predictable revenue with high gross margins and without revenue concentration? …
Think about it
2 thoughts on “What kind of business investors seek”
Very useful article. Thanks a lot.
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Thank You Amr. 🙂