Most companies are valued by applying a multiple to the businesses EBITDA (earnings before interest taxes, depreciation, and amortization). However, buyers will closely examine the revenue streams generating that EBITDA and assess the quality thereof. Here are a few things buyers will look for when assessing a company’s revenue streams.
1. Revenue Consistency
The more stable and predictable the revenue stream and the profit therefrom, the more the buyer will be willing to pay. This provides forward visibility and mitigates risk, because the revenue can be counted on in the future with a high degree of certainty. Most subscription models would fall into this category. Assuming customer churn is low, and the lifetime value of the customer outweighs the customer acquisition costs, buyers will pay up for this type of business model. On the flip side, earnings generated from project based work or one-time events will typically be heavily discounted.
2. Customer Diversity
One strong customer can get a business up and going, but diversity is required to mitigate risk. This also applies to customer concentration within revenue streams. If the revenue stream would suffer meaningfully due to the loss of one or two customers, buyers will take this into account. Customer concentration will not only lower the value of a company but might scare off buyers altogether.
Buyers will pay great attention to a company’s margins and assess the overall business by comparing margins to like companies. Superior margins oftentimes mean a competitive advantage, which gives a buyer greater comfort that the revenue and profit therefrom is protected. In addition to looking at a company’s overall margins, buyers will assess the margin contributed by each revenue stream. Growth in revenue streams with higher margins will be rewarded, while revenue with lower margins, even if growing, will often be discounted.
These are important factors to consider when operating and growing your business. Yet, every company and industry is different and not every business model can have the recurring revenue and customer diversification of Netflix. If you want to know how you measure up in these areas, benchmark yourself against competitors or companies with a business model similar to your own. Taking action to improve and be the best among your peers in these areas will not only increase the value of your company, it will mitigate the risk you have as an owner.
About The Author
Zane Tarence, Partner and Head of Founders Advisors’ Technology and Business Services Group, is an experienced investment banker, entrepreneur and recognized expert on the growth and monetization of digital media, internet technology and software companies. Over the past 20 years, Zane has led and completed more than 87 technology deals, including facilitating the sale of some of the largest lead generation internet businesses in the United States. Zane is a noted speaker with Vistage International and Convene. He is the founder of the preeminent SaaS and internet summit, Silicon Y’all. Zane is the author of 17 Reasons Your Company Is NOT Investment Grade.