How to Value Companies with Recurring Revenue

Let’s say you wanted to sell your company today. Do you know how much it would be worth?

It’s a question that often pops into the minds of business owners, whether they’re actively trying to sell their company, seeking investors, or planning for the future. But here’s the twist: if your business model includes recurring revenue streams like subscriptions or memberships, your valuation process may look different compared to a business that relies solely on one-time sales. 

Understanding your company’s value is more important than you might think. Let’s dive into why it matters and explore the best methods to see how much your company may be worth.

What is Recurring Revenue?

Obviously, one-time sales generate profit through each individual transaction, but they require a customer to think of your brand and actively seek out your product each time they need it. That’s why recurring revenue can be a game-changer for your company.

Recurring subscriptions or memberships offer your company a far more predictable cash flow. They provide a consistent source of revenue, meaning more certainty as you plan for the future.

Today, 90% of consumers in America are subscribed to at least one product or service. Whether you’re watching that new show on Netflix, getting free one-day delivery from your favorite retailers, or streaming music while you work, subscription-based services have become the new norm.

The software industry has also gotten into the game. Many software-as-a-service (SaaS) companies like QuickBooks and Adobe now offer their products only on a subscription basis, as opposed to in the past, when software was a big one-time purchase every few years.

Everything from the internet to apps on your phone now requires a subscription, which means regular, reliable profits for your company.

Why Value Your Company?

Why should you value your company as a business owner? Why does it matter how much your company is worth?

A valuation is more than just a number; it’s a powerful tool that provides deep insights into your company’s operations, financial health, and long-term viability. It helps you identify areas for improvement in your operations and revenue streams.

Many business owners only start to seriously think about the value of their company when they’re looking to sell. But valuation is not only for building an exit strategy.

Knowing your company’s worth can also help you when you’re looking to secure additional funding from investors. 

Investors are particularly attracted to companies with recurring revenue, as it is more predictable and stable than one-time sales models. A business with a loyal customer base and guaranteed future income streams is highly appealing to potential investors and buyers, who want to ensure their financial risk will pay off.

Even if you’re not looking to sell your company, understanding your company’s value is still essential. This can help you plan for your financial future and understand how financially viable your business model is.

Now that you see why valuation matters, let’s take a look at specific methods you can use to determine your company’s worth.

What Methods Can Be Used to Value Your Company?

There are multiple ways you can value your company, depending on its size, structure and sales mix. 

Valuation is a complex process, especially for privately-owned companies, and it should be done accurately. Mistakes in valuation can misrepresent your company’s true worth, whether inflating or deflating its value, which can significantly impact on your exit strategy. Consider having a team of financial experts advise you through the process.

Times-Revenue Method

The times-revenue method values a business based on its cash flow and industry. It works by multiplying your annual revenue by an industry-specific multiplier, updated yearly by NYU. This multiplier expresses the overall potential of a business given shared circumstances like target markets, competitors and typical margins.

This method is most common with startups and fast-growing small businesses, as it is simple to calculate. It’s also popular within highly profitable industries like software, which tend to have higher industry multipliers.

However, revenue doesn’t equal profit, and this valuation method doesn’t take into account whether a company is actually capable of making a profit. It’s a good idea to use multiple valuation methods to get a fuller sense of your company’s value and potential.

Discounted Cash Flow Method

The discounted cash flow method, or DCF, estimates the current value of future cash flow projections while accounting for risk and inflation.

The DCF method works well for companies that make most of their money from predictable recurring revenue streams, as it requires you to be able to predict how much money you will be making in the future.

One important metric used in this context is the Annual Recurring Revenue (ARR). The ARR provides a snapshot of your company’s recurring revenue on an annual basis, helping you estimate your future cash flow. It is calculated by multiplying your monthly recurring revenue (MRR) by 12 or by summing up the total annual subscriptions and other ongoing revenue, and then subtracting cancellations.

As with any type of forecasting based on current numbers, your financial projections should be up-to-date and accurate. This can be challenging for startups and early-stage businesses, which might not have enough solid data to make accurate conclusions. 

Comparable Company Analysis

Similar companies within the same industry are often valued similarly. The comparable company analysis method identifies other companies within your industry that have recently been acquired and that share a similar size, potential, and risks. 

By examining the sale prices of similar companies, your financial advisor can help you understand how much your company might be worth.

Market Capitalization

Publicly traded companies can be valued using different methods than privately owned businesses. 

If your company is publicly traded, you may consider using market capitalization to value your company. This method multiplies your company’s current share price by the total number of shares, which gives a good current estimate about how much demand there is for your company.

Unlock Your Company’s Value with Finvisor

You’ve put in the hard work to build and grow your company, and whether you’re seeking additional financing or planning an exit strategy, understanding your company’s true value is key to maximizing your efforts. At Finvisor, we bring over a decade of experience advising small and medium-sized businesses like yours—from inception to exit.

Ready to work with us? Reach out today and see how our financial advisors can help your company figure out your value.