Last month, Darden, the owner of the Olive Garden restaurant chain, announced it was acquiring Ruth’s Chris, the legendary American steakhouse, for $715 million, implying a valuation of around one times last year’s annual revenue, or about ten times their adjusted EBITDA for 2022.
Not bad for a giant company. But Ruth’s Chris’s value was likely hindered by its lack of recurring revenue.
Comparing Ruth’s Chris to another traditional business with recurring revenue demonstrates the power of automatic customers. For instance, Waste Management, a private garbage collection company that disposes trash for clients through long-term contracts, trades at over three times its annual revenue.
Two companies in traditional industries have nothing to do with software, yet one trades at one time revenue while the other fetches three.
Recurring Revenue: Not Just for Software Companies Anymore
Many people consider recurring revenue to be exclusive to software companies, but traditional businesses can also reap the benefits of creating recurring income streams. For example, let’s look at Gamal Codner, the founder of Fresh Heritage, a line of men’s grooming products that began with beard oil for softening facial hair prior to shaving.
Codner used Facebook ads to acquire customers at a cost of around $15 each. However, with an average order value of $30, there was little margin left to support his expanding operation. Recognizing the need for change, Codner decided to broaden his product line by introducing additional grooming offerings and launching the VIP Club, a subscription program for men wanting automatic shipments of Fresh Heritage products.
A Subscription Program That Goes Beyond Just Discounts
Codner conducted an in-depth survey among approximately 500 customers and made an intriguing discovery. He found that his target customers were less captivated by discounts and more attracted to the empowering notion of being an alpha male in their respective fields. The insightful results from this survey perfectly aligned with Fresh Heritage’s inherent goal of building a distinct brand that appealed specifically to growth-oriented men, those who were keenly focused on boosting their self-confidence.
Subsequently, to incentivize men to join the VIP program, Gamal moved beyond merely offering financial incentives such as discounts. He strategically created a sense of community and belonging by emphasizing membership in a group of like-minded individuals, all striving for personal excellence. Gamal established quarterly local area meetups to nurture this sense of community, providing valuable opportunities for members to network and share experiences. These empowering gatherings soon evolved into a significant driving force, steering new customers toward the experience offered by Fresh Heritage’s VIP program.
Converting Customers into Subscribers
Gamal continued to acquire customers through Facebook advertising. Instead of relying on one-time purchases, he successfully converted them into subscribers, significantly increasing their lifetime value. The average order value also surged to over $60, and with the subscription program expanding to 3,000 members, Codner’s EBITDA margin grew to 40%.
That got the attention of BRANDED, an aggregator of digitally native, direct-to-consumer brands that made Gamal an acquisition offer he couldn’t refuse in 2022.
Recurring revenue will make your business more valuable. As the example of Fresh Heritage demonstrates, you don’t have to be in the software business to create an annuity stream. Find out what your customers crave on an ongoing basis, and you will have the raw material for a subscription offering.
Benefits of a Recurring Revenue Model
Recurring revenue can be a real game-changer for companies. This business model offers several benefits, such as:
Provides an Appealing Business Package for Investors
Private equity investors and managers look for businesses that have recurring revenue. They know that such business models deliver an accurate assessment of future sales and income. Investors don’t have to worry about chasing after customers or wondering where/when they will get more customers.
Proves to Be an Effective Annuity Stream
A business with a steady stream of subscription-based or contract-based customers is a proven, effective model for profitability. Whether it’s SaaS or another recurring revenue model, the key factor is that it isn’t a “once and done” type of customer.
Boosts the Value of Your Business
You only need to look at the Planet Fitnesses of the world to see the benefit of recurring revenue in action. Private equity investors love businesses like these because their selling value is often 4 to 8 times EBITDA.
Obviously, a subscription or membership-type business will have predictability. The business has a good idea of what the P&L is when they have regular customers. Also, many of these businesses, such as Planet Fitness, will offer autopay for convenience. The money comes automatically out of the customer’s bank account every month. They don’t have to do anything.
Even if the customer doesn’t use the membership service, the payment still gets made. With a gym membership, customers often sign a one-year contract. So, even if they decide they don’t want the service any longer, they are locked into the year. And often, customers will continue to pay for the membership “just in case” they want to use it.
Plus, it’s an extra effort to turn off auto-pay. Customers might even forget what subscriptions they have after a period of time. Meanwhile, the company keeps collecting predictable revenue.
It May Reduce Expenses
Some businesses have fewer expenses due to the recurring revenue. They may not require as much advertising costs, or they have reduced overhead. Using the gym membership as an example, business owners can usually count on customers not using the equipment regularly. This reduces replacement and repair costs.
Traditional Businesses Can Find Recurring Revenue Streams Too
Subscription business models can be key to enhancing your business’s value, even for traditional lumpy business models, like construction or HVAC. Construction or HVAC companies can establish service departments and with every install, sell a service contract to do annual inspections, cleaning, or even repairs. This recurring revenue will make your business more valuable upon an exit.
Some businesses sell (and install) big-ticket products that won’t need replacing for a decade or more. For example, HVAC companies fall into this category. At first glance, it may seem that they don’t have options for recurring revenue. However, they can boost their business valuation by offering service contracts when they sell their equipment.
Instead of just providing and installing the HVAC equipment and having a “once and done” type of sale, contractors can generate an ongoing income stream with a service contract that includes annual checkups and/or regular maintenance. The contract could even specify a discount on future repairs for the equipment. For example, if someone purchases a new furnace, the HVAC business can sell a service contract that would include an annual inspection, quarterly filter changes, and a 10 % discount on any other service or repairs.
Auto dealers have the same opportunity. When they sell a new car, they can offer a contract for “X” amount of dollars that provides oil changes and tire rotations for the contract period.
Businesses can customize the contract to fit their company and customer base. So, what is included in the contract is up to the business. The point is to implement some type of recurring revenue stream, whether it’s for a subscription or a contract.
Learn More About Adding Recurring Revenue Streams to Your Business
Subscription business models are key to enhancing value for all types of companies and will make a business more valuable upon the exit, especially if the buyer is a private equity firm. Private equity will pay up for companies with growing, recurring revenue, especially if there is a strong management team in place.
Learn more about how to boost your business’s value through recurring revenue. Contact Twelve Points Business Advisors today.