The Link Between Customer Retention and Business Valuation
While all of this is happening, you’re also working to provide the kind of quality and value that will build your reputation and create a thriving customer base.
With so much of your attention focused on the hamster wheel of customer attraction, retention, and service, it’s easy to lose sight of the big picture: the overall value of your company.
Planning for the Future by Building Value
Even if selling your company has never crossed your mind, it’s something every business owner should plan for. At some point, you’ll likely want to retire or move in a new direction. When you do, the key to getting the maximum value out of your dealership will be your loyal base of return customers.
Why do return customers matter? Having a strong base of recurring customers means being able to show recurring revenue — something that will be attractive to a potential buyer down the road.
If you’ve got a healthy flow of new customers and net profit that’s growing year over year, you may shake your head and wonder why a large volume of recurring revenue should matter. You’ve generated a healthy “blue sky” valuation by multiplying your EBITDA (earnings before interest, taxes, depreciation, and amortization) by your growth. For a large buyer, however, one of the most important factors they’ll investigate is how much of those earnings is generated through recurring revenue.
Customer Retention and Business Valuation
From security alarm companies to software companies and auto dealerships, customer retention is important both in day-to-day operations and in the eyes of private equity investors. It costs five times more to attract a new customer than to convince a current one to return. Recurring customers do more than just bring down your cost of sales, however: they’re also a guaranteed flow of future revenue.
Consider why recurring revenue numbers would be attractive to investors. An alarm company that sells and installs 1,000 units one year may only sell 750 the next year. If they’ve convinced each of those customers to purchase an annual subscription to their security monitoring service, however, they’ve created a stable flow of recurring revenue. Unlike one-off sales that are unpredictable and can ebb and flow, owners can depend on returning customers and subscription sales to provide a steady stream of income.
How Does Recurring Revenue Affect Your Valuation?
What does all of this mean for the value of your business? Having a strong recurring revenue stream can be the difference between getting a moderately good price when you sell company and walking away with the maximum value for all that you’ve worked to build.
While numbers differ from one industry and even one business to the next, the software industry provides an excellent example of how recurring revenue can affect your final valuation. While companies that sell perpetual licenses for SaaS software often average 3x revenue multiple, those who can show a strong flow of recurring revenue can command a whopping 6x revenue multiple.
This is why it’s important to build that loyal returning customer base as well as be able to demonstrate how much of your revenue stream is made up of recurring revenue. Maybe you have customers buying into long-term warranty or maintenance plans or perhaps you can show how your company brings the same customers back two, three, or even four times to buy new products or from your business. Either way, these numbers demonstrate stability and reliability for the long-term. Whether you plan to sell sometime soon or years down the road, that’s a strong foundation on which to build — and one that investors are more likely to bet on.