Finding tomorrow’s money

Potential buyers will analyse the level at type of revenue your business generates. Repeating revenue is worth more than ad hoc, one-off sales.

Finding tomorrow’s money

While the market analysts and regulators are still trying to track down who actually ended up with the bad debts generated by the US sub-prime mortgage market, private equity buyers in Australia are undertaking a financial search of a different kind. They are trying to find future income they can bank on.

With many of today’s businesses structured in a way that minimises the physical assets through property rental, vehicle and equipment leasing as well as just-in-time inventory, what have traditionally been business assets have become, albeit smaller, ongoing expenses. Add these to interest payments on the loan used to buy the business and the business has some substantial financial obligations to meet, even when it is sitting idle. This brings the need for reliable ongoing future revenue into sharp focus. It is a point not lost on potential buyers.

If you are selling a business don’t be surprised if you are asked to split your income into repeating revenue and ad hoc revenue. Repeating revenue is constructed of things such as long-term service contracts or regular and reliable customers.

Ad hoc revenue, on the other hand, would be such things as single sales or individual projects. Buyers will pay a premium for repeating revenue and discount ad hoc revenue. There is some sense to this.

If your customers only ever require one of your products – say, a garage door – then the more successful you have been prior to the sale, the smaller the potential market is for your successor. If on the other hand your customers could purchase from you on a regular basis – you are a food retailer, for example – then the more successful you have been in building up their buying habits the greater the potential market for your successor. Of course, there are products and services across this full spectrum, from once-in-a-lifetime to everyday items, but it is important to understand the relative values of the different kinds of income streams.

Further to this, if the buyer believes that the current owner is a major factor in stimulating the revenue, then be prepared for a workout clause to be requested as part of the purchase negotiation. Essentially the buyer is trying to buy the time to establish the customer’s loyalty with the business rather than the previous owner.

For business owners looking to sell in a few years from now, work on maximising the repeatable revenue components of your business. Even if you don’t sell, it will make it easier to sleep at night knowing where your future income is going to come from.

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