Republished with permission from Built to Sell Inc.

Many people mix up re-occurring and recurring revenue, but one is much more valuable than the other.

Re-occurring Revenue

Re-occurring revenue comes from customers that have a re-occurring need for whatever you sell and buy from you on an unpredictable yet regular basis.

Imagine a health food store. Customers come in to replenish their supply of vitamins when they run out. The owner is never quite sure when a customer will be back, but she’s pretty sure they will return when they run low on a critical supplement.

Recurring Revenue

Recurring revenue comes from sales to customers that buy from you on a predictable, automatic cadence, for example, a subscription or service contract.

Let’s take the same health food store owner. She recognizes her customer comes in every month or so to buy Vitamin C. She decides to offer a subscription for Vitamin C capsules, where she ships a new bottle to her subscribers each month automatically. The customer doesn’t need to make a dedicated trip to her store, and the owner automatically gets repeat sales.

Compared to one-off transaction revenue, both re-occurring and recurring revenue contribute positively to your company’s value, but one is much more valuable than the other.

For example, Mike Malatesta created Advanced Waste Services (AWS), which helped businesses dispose of their industrial waste. Energy giant Covanta (NYSE: CVA) saw acquiring AWS as the perfect way to enter the industrial waste industry and sent Malatesta a Letter of Intent to acquire AWS for $54.5 million.

Covanta liked that AWS had repeat business from loyal customers that they assumed were on recurring contracts. However, when Covanta started their diligence before closing their acquisition of AWS, they realized some of AWS’s revenue was re-occurring, not recurring, and used that as justification to lower their offer by $4 million.

To convert re-occurring revenue into recurring revenue:
1. Start by segmenting your customers that buy on a re-occurring basis.
2. Look for a segment whose purchase cadence is relatively predictable.
3. Design an offer for your regular, re-occurring customers that makes it more convenient for them to buy on a subscription or service contract rather than on a transactional business model.
4. Aim to give re-occurring customers three compelling reasons to subscribe.

For example, in the case of the vitamin store owner, she could make the case that subscribing to a regular shipment of vitamins is 1) more convenient for the customer because there is no need to drive to the store, 2) more reliable because subscribers would be given priority on available stock, and 3) safer because vitamin subscribers would be given a newsletter describing new clinical trial results of emerging vitamin therapies.

Re-occurring and recurring revenue may sound similar, but when it comes to your company’s value, recurring revenue is far better. Consider converting your re-occurring customers into subscribers, and you’ll build a more predictable—and valuable—business.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight-part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Republished with permission from Built to Sell Inc.

Is it better to own a big chunk of a small business or a minority stake in a big company?

It’s one of the fundamental questions all owners must wrestle with. Owning a relatively small slice of a big pie has worked out well for both Elon Musk and Jeff Bezos, who recently traded places on the list of the world’s richest person. Musk still owns around 20% of Tesla, and Bezos controls about 10% of Amazon, so they both have chosen to sell most of their company to fund their ambitions. The success of their bet has been amplified lately given the stock market’s run over the last 12 months.

However, selling part of your business comes with some significant downsides. Let’s take a look at four reasons it’s better to own a big slice of a smaller pie.

Operational Freedom

The most obvious benefit of keeping all of your shares is that you get to decide how to run your company. Nobody can tell you what products to launch or markets to enter. You are the king or queen of your kingdom and can decide the rules.

No Pressure to Exit

Tim Ferriss, the author of five books, including the wildly popular New York Times bestseller The 4-Hour Workweek, recently urged his Twitter followers to consider their endgame before investing in a business: “Before you get into an investment position, know how and when you’re going to get out, or at least how and when you will reevaluate. Getting in is the easy part….”

Once you accept outside investment in your business, you must try to earn your shareholders a return. For your investors to realize a gain, you must sell your company (or part of it). Needing to sell so your investors can realize a return means you give up the option to run your business forever and need to start thinking about how your shareholders will get liquid. Some will pressure you while others will wait patiently, but the exit clock starts ticking once you take outside investment.

Nobody Ahead of You in Line

Sophisticated outside investors often demand preferred returns when they invest in your company, which can undermine your take from a sale.

For example, Ana Chaud started Garden Bar to offer fast-casual salads to Portland hipsters. The first store was a success, but the restaurant industry’s thin margins inspired her to grow to get some economies of scale. She raised two rounds of outside capital, including one from a group of convertible noteholders. Chaud skimmed the term sheet but trusted her investors, so she didn’t think much about a clause that gave noteholders 2.5 times their money if she sold the business before the note expired.

Chaud continued to grow to nine locations, with a tenth on the way, when she attracted an exciting offer from Evergreens, Seattle’s fastest-growing salad restaurant. Things were going according to plan right up until Chaud’s lawyer pointed out the investors clause, which had the potential to wash out all her equity.

Chaud agreed to give the proceeds of her acquisition to investors. She negotiated an earn-out, which she hoped would allow her the possibility of a return on her years of sacrifice. Then COVID-19 hit, Portland restaurants were closed, and Chaud ended up with nothing.

Avoid an $80 Million Mistake

The most obvious reason to hang on to your shares is to avoid dilution. When your company is not worth very much in the early days, it can be tempting to give away equity to attract a key team member, but it could end up costing you dearly if you’re too generous.

Take a look at the story of Greg Alexander, who started Sales Benchmark Index (SBI). Alexander started the sales consultancy at his kitchen table and, early into his tenure, gave two employees a quarter share in his business. Ten years later, Alexander ended up selling SBI for $162 million, prompting him to refer to easily giving up half the company as an “$80 million mistake.”

Given the runaway success of some high-profile stocks of late, it can be tempting to consider raising money to fund your growth, but there are still several benefits to owning a big slice of a small pie.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Republished with permission from Built to Sell Inc.

Finally, 2020 is in the books.

Good riddance.

If your goal is to build a more valuable company in 2021, here are some New Year’s resolutions to consider:

1. Stop chasing revenue. A bigger company is not necessarily a more valuable one if the extra sales come from products and services that are too reliant on you to deliver them.
2. Start surveying your customers using the Net Promoter Score methodology. It’s a fast and easy way for your customers to give you feedback, and it’s predictive of your company’s growth in the future.
3. Sell less stuff to more people. The most valuable companies have a defendable niche selling a few differentiated products and services to many customers. The least valuable businesses sell lots of undifferentiated products and services to a concentrated group of buyers.
4. Drop the products or services that depend on you. If you offer something that needs you to produce or sell it, consider dropping it from your offerings. Services and products that require you suck up your time and cash and don’t contribute significantly to your business’s value.
5. Collect more money up front. Turn a negative cash flow cycle into a positive one and you boost your business’s value and lessen your stress load.
6. Create more recurring revenue. Predictable sales from subscriptions or recurring contracts mean less stress in the short term and a more valuable business over the long run.
7. Be different. Refine your marketing strategy to emphasize the point of differentiation that customers value. Be relentless in highlighting this advantage.
8. Find a backup supplier for your most critical raw materials. Consider placing a small order to establish a commercial relationship and diversify the sources of your most-difficult-to-find materials.
9. Teach them to fish. Answer every employee question of you with “What would you do if you owned the business?” Your goal should be to cultivate employees who think like owners so they can start answering their own questions without coming to you.
10. Create an instruction manual. Document your most important processes so your employees can do their work independently.

Here’s to building a more valuable company in 2021!

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Republished with permission from Built to Sell Inc.

Have you struggled to identify a recurring revenue model that will work in your business?

If so, you’re not alone.

Most owners understand the benefits of recurring revenue, such as predictable cash flow and an increase in their company’s valuation, but struggle with where to start. Just changing your pricing from a one-time transaction to a smaller, recurring fee does not make a sticky subscription model.

The first step of creating a recurring revenue model for your business has nothing to do with your billing platform and everything to do with your target customer. The secret to reimagining your business into a recurring revenue juggernaut is to niche way down.

Niche Down

For a recurring revenue model to retain subscribers, it needs to provide an outlandishly attractive value proposition to customers who agree to continue with the service over the long run. To create that kind of delight, you have to find a pain point where a group of customers feels uniform. That only happens when you niche way down.

For example, when Jorey Ramer, the founder of Super, moved to the San Francisco Bay area, he purchased a home. Ramer had previously been a renter and was surprised by the hassles of owning a house.

Ramer realized that everything from the ice maker in his fridge to the lighting in his backyard was susceptible to failing. He decided to create a subscription model that would allow homeowners to pay one monthly fee in return for a mobile app where subscribers can summon a repair person to fix just about anything that could break down in a home.

Last year Ramer raised $20 million from investors, who see the opportunity in putting home repairs on subscription.

Ramer’s first step in creating Super was not to put out a shingle as a home repair professional with a different billing model. Instead, he focused on niching down to a customer group with a common need. To begin segmenting, he picked homeowners. Then Ramer went further and identified a subsegment of homeowners who are not do-it-yourself types.

Some homeowners are tinkerers and don’t mind digging into a “honey-do”” list every weekend, but Ramer knows those aren’t his people. Instead, he chose to focus on the sub-niche of homeowners that don’t want the hassle and surprises that come with homeownership.

How Peloton Made Their Subscription Sticky

At Peloton, the fitness company that started with a souped-up stationary bike and now includes classes on everything from yoga to running, they have adopted a subscription model. Customers buy the bike (or the treadmill) and then subscribe to Peloton’s content package. To make Peloton’s subscription sticky, they didn’t just target people who wanted to get fit, many of whom were happy to go to a gym before the pandemic. Instead, they targeted relatively affluent people who are too busy to go to the gym. While the single twenty-something sees a spinning class at his local gym as a chance to connect with like-minded people, Peloton knew the forty-something mom with three kids often doesn’t have the time to go to the gym. Therefore, they defined their target customer as relatively affluent fitness enthusiasts who don’t have time to go to the gym—a niche of a niche.

Year to date for 2020, Peloton’s share price has more than tripled.

If you’re stuck trying to come up with a recurring revenue model that would work for your industry, segment your customers based on what makes them buy from you. Then determine if one of your niches has a recurring need for something you sell.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Republished with permission from Built to Sell Inc.

When was the last time you calculated the percentage of your net worth tied to your company’s value?

When you started your business, its value was probably negligible. Unless you purchased or inherited your company, it wasn’t worth much when you opened your doors, but over time, the proportion of your assets tied to your business may have crept up.

Let’s imagine a hypothetical business owner named Tim, who starts his company at age 30. He has a little bit of equity in his first home and a small retirement fund. When he starts his business, it’s worthless, so it doesn’t yet factor into Tim’s net worth calculation.

By the age of 50, Tim has built up $600,000 worth of equity in his home, his retirement nest egg has grown to $400,000, and his business has blossomed and is now worth $4,000,000. Tim’s company has crept up to represent 80% of his net worth.

Tim knows the first rule of investing is to diversify, which he is careful to do with his retirement account. Still, he has failed to achieve overall diversity given the success of his business.

What’s more, he may have unknowingly passed something called “The Freedom Point,” which is when the net proceeds (i.e., after taxes and expenses) of selling his business would garner enough money for him to live comfortably for the rest of his life. Your lifestyle determines your Freedom Point, but when you pass it, it’s worth considering the risk you’re taking.

If this pandemic has taught us anything, it is that nothing is for sure, and a thriving business one day can turn into a struggling company overnight. When your business makes up most of your net worth and selling it would garner enough money to retire, there’s no financial reason to continue owning your business. You may enjoy the challenge, the social interactions, and the creative process of building a business, but keeping it may be unnecessarily risky.

When you’ve crested the Freedom Point and want to diversity—but still don’t want to retire—you have some options:

• Sell a Minority Stake: In a minority recapitalization, you sell less than half of your shares. Often sold to a financial investor such as a private equity group, a minority recapitalization allows you to diversify your net worth while continuing to control your business.

• Sell a Majority Stake: In a majority recapitalization, you sell more than half of your shares to an investor who will most likely ask you to continue to run your business for many years to come. You get to diversity your wealth, keep some equity in your business for when the investor sells, and continue to run your company.

• Earn-Out: When you sell your company, you’ll likely have to agree to a transition period of sorts. One of the most popular is called an earn-out, where you agree to continue to run your company as a division of your acquirer’s business for a specified period of time. Your earn-out may be as little as a year or as long as seven, but the average is three years. Therefore, if you’re past the Freedom Point and can see yourself wanting to step down in the next three to five years, an earn-out may be worth considering.

Building a successful business is rewarding, but when your personal balance sheet gets out of whack, it may be worth considering the risk you’re shouldering and the options you have for sharing some of it.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.

Republished with permission from Built to Sell Inc.

As we roll into the fourth quarter of the year, you may be starting to consider your business goals for next year.

Given how 2020 has gone, maybe your primary ambition is to survive in 2021. Perhaps you’re going to create a recurring revenue stream or finally hire that general manager. Or maybe you’ve decided to start preparing for an exit.

Whatever your goals are, the most important thing you can do now is write down your plan to achieve them.

A Revealing Study

This point was driven home recently by a study published in the British Journal of Health Psychology. The project was designed to see what impact stimuli would have on participants’ level of exercise. Researchers divided a random sample of participants into three groups.

For the first group, the researchers asked the participants to track how frequently they exercised. They were told to read a passage of an unrelated book before beginning.

For the second group, researchers wanted to measure the impact that motivation would have on their exercise levels. The second group was also asked to track their activity levels and were then told to read a book’s motivational passage that outlined the benefits of exercise for maintaining a healthy weight.

The third group was asked to read the same motivational excerpt as the second group but had the additional task of writing down their exercise goals for the coming week.

The Results

When the researchers sat down to analyze the results, they were surprised to find that among the motivated group (group 2), just 35% exercised once per week. That was slightly less exercise than group 1 (36%) even though they were motivated to work out.

When the researchers analyzed the third group’s exercise log, they were stunned to find that 91% of them had worked out. The only difference between groups 2 and 3 was that the third group was asked to write down their goals. That simple task seems to have almost tripled their likelihood to succeed.

The researchers concluded that motivation alone has virtually no impact on our actions. Instead, it is motivation coupled with a written action plan of how you’re going to achieve your goals that has the most significant impact on your results.

Food for thought as you start thinking about making 2021 your best year yet.

For more free information on Creating A Business Owner’s Dream Financial Plan, you can listen to a free, eight part series we did exclusively for business owners. The show is also available to subscribe to for free via iTunes.