Earlier this week I signed a new book deal to write about the subscription economy. I’m aiming to have the first draft over to Random House this spring for an early 2015 release.
I see this new book as a sequel to Built to Sell in many ways. Built to Sell focuses on setting your business up to be sellable, and once you have the fundamentals in place, the next big step in the journey is to create a stream of recurring revenue an acquirer can count on when you leave.
I touched on recurring revenue in Built to Sell, but my new book will be a total immersion into the world of subscriptions. My thesis is that every business can and should consider launching a subscription offering. Some companies like Apple, Target, Time Warner Cable and Amazon are adding a subscription service to complement their pre-existing business models.
Other businesses, like H. Bloom (fresh cut flowers), Koge (vitamins) and TIGER21 (investments), are starting up with a subscription model as the core of their business. Whether you want to remake your entire business or just tweak it by adding a small subscription offering, any amount of recurring revenue will have a positive effect on the value of your company.
What happens if you decide not to add a subscription offering
To illustrate, it’s worth spending a few minutes discussing how your company will be valued if you decide not to have a subscription offering.
The most common methodology used to value a mid-sized business is called Discounted Cash Flow. The acquirer is placing a value on the stream of profits your company expects to make in the future. Simply put, the riskier your future profits appear to an acquirer, the higher the discount rate and the lower your valuation.
Over at SellabilityScore.com, we see this relationship between risk and value play out every day. Since 2012, we have been tracking the offers received by the business owners who complete our questionnaire. During that time, the average business (with at least $3 million in revenue) has been offered 4.6 times their pre-tax profit.
This means that a traditional business churning out 10% pre-tax profit on $5 million dollars in revenue can reasonably expect their business to be worth around $2,300,000 ($5,000,000 x 10% x 4.6).
How to quadruple the value of your company
Let’s compare that to a successful subscription business. As part of the research for my new book, I recently spoke with Dmitry Buterin, who is the founder of the subscription-based software company Wild Apricot, and who, up until recently, also ran a MasterMind group of other SaaS (Software as a Service) companies. Each month, the group met to discuss strategies for running a subscription business, and they regularly discussed the valuation multiples being offered to member companies. Buterin noted that the consensus valuation range being offered to his member companies was between 24 and 60 times monthly recurring revenue (MRR). Said another way, 2 to 5 times revenue.
Boris Wertz is a Vancouver-based entrepreneur turned venture capitalist who runs a fund called Version One Ventures. Version One has invested in a number of subscription businesses like Julep and FrontDesk. I spoke with Wertz about valuations, and he estimates the value of a successful subscription business even higher. According to Wertz, a subscription business doubling MRR every year might fetch 80 to100 times MRR.
In rare cases, a subscription company may even exceed Wertz’s 100 times MRR figure. Workday.com is a very fast-growth software company that sells a system that jams together your finance and HR department. Workday recently traded at a whopping 360 times MRR.
Salesforce.com, another publicly traded darling of the enterprise software space, was trading around 96 x MRR at the end of 2013.
Even mature, slower-growth subscription businesses sell for a significant premium. The company behind Ancestry.com was started back in 1983 and it came of age as a dot-com all the way back in the late 1990’s. By the end of 2012, Ancestry.com had two million subscribers, and the revenue across all of its sites was $487 million, up about 25% from the year before. On December 28, 2012, Ancestry.com was acquired for $1.5 billion or roughly 37 x their MRR of around $40.5 million.
Putting very large company valuation aside, the case for a subscription business is compelling. On the one hand, you can have a traditional business generating 10% pre-tax profit on $5 million in revenue with a value of around $2 million. On the other, you have a company that could be worth a whole lot more. Even if you use the lowest point on Buterin’s range, which is 24 times MRR, your $5 million dollar per year subscription business may be worth closer to $10 million ($5 million divided by 12 x 24).
Be one of the first 60 business owners to get a sneak preview of my new book
We’re going to dedicate a big chunk of the Built to Sell Workshop Feb 28-March 2 to setting up and running a subscription business (either to add a new revenue stream to your existing business or as a standalone business unit). It will be the first time I reveal some of the core ideas in the new book so I hope you’ll plan to attend. Sign up by January 31 and save $600.