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From Paul Spencer of Second Nature Solutions, a conversation about the complexities and nuances of building resilient family enterprises, especially in the face of economic and political uncertainties that loom on the horizon. See more at secondnature.solutions.
Welcome to Resilience Talk hosted by
Paul Spencer of Second Nature Solutions.
Let's dive in.
Paul Spencer: You've committed a
lot of time and a lot of money into
your business whenever you started
it, whether that was 10 years ago,
50 years ago, or even yesterday.
You've made the sacrifice and the
commitment to build something, and
that's what we're talking about
in our ownership series is not
only are you, have you invested.
Time and money and maybe even pulled
money from your savings, maybe even taken
a pay cut and you're paying employees
or you are, um, getting your services
or product off the ground and you're
either not getting any money or you're
getting very little money as compared to
if you just got a job out in the market.
And so this is well known and it's part of
the sacrifice, but it's also part of the
fun and the reason why we own businesses.
And so as an owner and as part of our
ownership series, we're trying to get,
uh, a new angle, a new mindset into
what is the purpose of our business now.
Now we all have.
A mission and a vision for our
business, why we started it.
Sometimes it's just to make more money.
Sometimes it's because, just because we
think we can do it better, and sometimes
it's a more holistic view of the world and
we want to contribute and serve more in
a better way regardless of what that is.
You still have to have an understanding
that you own an asset, and that's
the purpose of the ownership series
that we've been talking about.
So today we're gonna be talking
about recurring revenue, which
is the fuel of the business, and
we'll go into some details on that.
But just to review.
What are the key evaluators of, um, how
do we appraise the value of your business?
Uh, there are eight that I'm gonna go
through, and again, as you've heard.
There can be less, there can be
more, there could be different ones.
If you talk to different people
or if you go out and you, you look
on the internet, you ask chat GPT.
Um, the point here is that you need
to have a focus of what is my asset
and how am I continually adding value?
Into my asset.
So we're gonna review those real quick.
Financial performance,
which we've talked about.
Growth, potential, key dependencies,
recurring revenue, which is what
we're gonna talk about today, right?
To win.
Corporate structure, key
management and leadership, and
then owner, owner involvement.
Um, so those are the eight that we're
gonna, that we're gonna review today.
We're gonna look at recurring revenue,
and you could see how all these are
intertwined and connected because when
we talked about financial performance.
Right.
We were forecasting, um, being able
to demonstrate historical revenue,
being able to, to, uh, demonstrate
predictable, consistent revenue.
And what's the input to that?
Well, the input to that
is recurring revenue.
And really from a buyer's perspective,
if we're going to go buy a business,
um, we're going to ask what is.
Your automatic revenue every month.
What's your annual recurring
revenue and what proportion?
Right?
What percentage of your annual
revenue or your monthly revenue
is based on reoccurring revenue?
How are you collecting this every month?
How consistent is it?
How reliable is it?
I've been with different.
Organizations where we talk about,
uh, days sold outstanding, right?
Which is when we send out an invoice,
we have some terms and we may say net
10, net 30, some of you go net 45 even.
And really it depends on the type of
service that you're providing, the type
of clients that you're working with.
But really you wanna get that as
close as possible, meaning your
net is as soon as we sign the,
the ink is dry on the contract.
Then I get paid.
Right?
That's the ideal.
We wanna have instant cash flow.
Now, is that realistic?
Not always, but that's what we strive for.
That's our aim, uh, anyway.
As an, as an owner or as a, yeah,
as an owner, but also as a buyer.
We're looking at that day sold.
Outstanding because that gives us a
sense of the health of the fuel, which
is the cash flow of your business.
Um.
Some of you out there that I've
worked with in the past, you've
had days sold outstanding.
That is, um, in the two hundreds,
in the high one hundreds.
And what does that mean?
That means that work that I did 200
days ago, I still haven't gotten paid.
Right.
Um, that is not, that doesn't mean
that I started a project in February,
finished it up in late September,
and I still haven't been paid.
That means I finished my work in
February, sent you an invoice, and
I haven't done any more work on that
particular project or job or whatever
that, whatever that deliverable was.
I'm done with it.
I've wrapped it.
It's yours, whatever it is
done, and I haven't, you haven't
paid me for over 200 days.
This is completely unrealistic.
It is, uh, poor, uh, inventory
management, um, revenue management.
And when we're a buyer and we're
looking at the health of the company,
that is a big warning sign, right?
If, uh, my average day sold
outstanding is more than 90 days,
then um, that's gonna reduce.
The value of your business.
All right, so when we're thinking
about how do we, how do we
establish reoccurring revenue?
Well, we just talked about it.
We have to collect, right?
So our accounts receivable,
our process around accounts
receivable, we need to focus on it.
And I know I've talked about
this a million times, that it's
uh, nine times outta 10 any.
Business, family owned business
has been around for decades.
Uh, doesn't tend to focus
much on the accounting side,
so the, the, the bookkeeper.
Uh, the accounting person that
might be internal is, has, probably
has the worst office or worst,
uh, desk location in the building.
Um, they just deal with
whatever's coming their way and
they do the best that they can.
Um, but you typically have poor
insight as an owner into the flow
of what I just described, right?
So we need to have a.
Healthy, mature process on the
accounting side, on accounts receivable.
So the other things that we tend to think
about, um, are gonna be more strategic and
then we can implement those and be more
tactile, um, when we get down into there.
Right.
More tactical.
So.
What is recurring revenue?
Well, it must demonstrate
continuous value, right?
It needs to be sticky.
If, if I'm gonna charge you $100 a
month or, um, $10,000 a month or $1
million a year there needs, you need
to demonstrate continuous value, right?
And the other thing is it needs to address
the pains and needs of the customer and
they, those pains and needs need to have.
Be continual.
It's not a, it's not a one-time medicine.
I know people talk about vitamin versus
medicine, vitamin versus aspirin.
Uh, we're not talking
about a one-time, uh.
Pain solution, and then now you're good.
The customer has to be continually
experiencing some kind of need,
and that is, um, something that
would fit in the recurring revenue.
Um, another thing that needs to
happen on our side as an asset, as
the, as our business is, as we scale.
So it, uh, as we have 10, 10 customers
and we get to 20, and then we get
to 100 and 1000 my profit should
start to increase, not decrease.
If I'm losing money as I scale, then my
recurring revenue model is not working.
Um, another thing that we talk about
when we think about sales, because
recurring revenue is a function of
sales, it's an input into sales.
Um, and it's an output of course.
Um, but it has to be easy to understand
and easy to buy for the, for the,
for the consum consumer, right?
For the buyer, uh, whatever product
and service that we're selling.
And so if it's not easy for me to
understand, it's very confusing.
Um.
Then I'm highly unlikely to buy it.
Easy to buy means that, uh, once I
decide that I want this, then, uh,
this goes to car, car sales, which
I recently bought a car, which was.
Pulling teeth.
It's so, so painful.
It sucks so bad.
Um, easy to understand.
Yeah, I want this car, I want this model.
I want these features.
Boom, done.
Easy to buy.
No, no capital, right?
It's six hours.
Six hours sitting in the dealership.
Waiting for all these things
is such a pain in the butt.
Is it easy to buy?
No.
How many times did I seriously consider
walking out and saying, I'm not buying
this vehicle three, maybe four times.
Right.
Maybe that averages out to a little
more than one an hour, a little more
than one every two hours, right?
Uh, that's not easy to buy.
So easy to buy means as soon
as I sign, boom, we're done.
Uh, simple contracts,
simple, simple payment terms.
We're done.
Alright, so let's go into
the continuous value side.
I think it's, uh, important to
be thinking about, uh, what.
Involves stickiness so
we can have consumables.
Right?
This is really helpful when we,
when you're going through strategic
planning and you're thinking about,
um, uh, how do we get, how do we
generate more recurring revenue?
And sometimes you have to go outside.
Of what you know, outside of
what you do, outside of your own
industry, to me, that that's what
we call, uh, divergent thinking.
Let's throw a bunch of ideas on
the wall that at, at first glance,
they're like, that's crazy.
What does that even look like?
That doesn't even make any sense.
And when you get divergent
thinking, then you can converge.
Now you've got lots of things on there
and you can take 1, 2, 3, and you're
like, oh, that is very interesting.
So that's what this part
of this process is for.
So we think about consumables, right?
It's natural to have recurring
revenue in consumables.
What's consumables food?
Right.
How often do you have to buy milk?
How often do you have to
buy bread, eggs, right?
Things that you have around your house,
your favorite brands, your favorite
foods, those are consumables and
they're, they're recurring revenue.
Um, meaning that you're gonna
buy them if, if they're things
that you enjoy often, right?
Um, another thing is
printer, right printer ink.
That's a consumable.
You buy the printer, the hardware.
You buy.
Another great example that
just came off the top of my
head is the, the Keurig, right?
You buy coffee, you buy a
coffee machine, uh, you consume.
That's the, that's the thing, the hardware
that you use to, to process a consumable.
So you may have the, the filter, the
coffee filter, you have the coffee.
Beans or they're already ground, right?
You might have a Keurig with a cup.
Those are things that you buy the
machine and then now you have to buy
consumables because you're consuming.
Right.
Another one would be, uh, fuel gas, oil
for your car, those kinds of things.
Uh, windshield wipers, if we get into
auto right, those are all consumable.
So you can start thinking about in
your business what are things that are
consumable that we can start to create
con uh, recurring revenue with consumption
based, which is, um, utilities.
So.
Your electricity, your gas for your
home, um, maybe even your water.
Um, on the technology side, anything
that's cloud-based, AWS comes to mind.
Um, Azure, um, you might even
pay for your, your Gmail or your.
Um, office 365 or Microsoft 365.
Um, those are consumptions, uh,
consum, uh, consumption based, right?
Uh, transactions is also a
consumption based thing, which
is, um, credit card fees.
Um.
Real estate, right?
You pay 7%, 6% for your realtor
to sell or buy your home.
Um, there could be different
brokerages, insurance brokerage, right?
You pay a fee for some of those things.
That's consumption based.
Um, there's operational based, right?
Um, meaning that.
Our product or our service, uh,
say a soft, like an ERP system is a
software operational based system that
you pay a, a reoccurring fee, right?
Uh, to use that system.
There's an implementation fee and
then a recurring licensing fee.
Um, long view service based, which
is just what I just talked about.
So if you buy an ERP system, you
probably pay a recurring maintenance.
Um, maybe there's some kinda warranty,
um, may, and then there's also probably a
management fee and those can be recurring.
Um, you can have product driven
fees, you can have subscription
based fees, like for SaaS based
products, which for me are, is like.
A little bit insane that we have
to pay, uh, $50, $300 a month for
some kind of SaaS based product.
I mean, you get into those RP systems and
you're talking about millions of dollars
every year, um, with high monthly costs.
Um, uh, it's, it is what we have today.
So I have opinion on that.
Obviously, um, other subscription based
things are just pure access based.
So, uh, I think about cable.
You think about your internet
subscription, that's just access to a
network, access to some kind of service.
Um, your cell phone, right?
Having a cell phone, access to
cell phone, network, and internet.
Um, you have d access to data.
So LexiNexis comes to mind
if you're legal, right?
You pay for access into their
cured, uh, curated, um, legal
systems and information.
Uh, there's lots of different.
Um, access based subscriptions, uh,
even content, like things that are
out there on the, on the internet.
Now, you may pay for a, um,
a substack subscription.
You may pay for a podcast, a particular
podcast, um, that's access based.
Um, uh, then you have value based.
Another one that's very interesting
is more around financial based.
So, uh, you may lease.
Um, a property you may lease, um,
uh, like we lease, um, high end.
Um.
What is the word?
Photocopiers.
Thank you.
In the, in the, like
in our offices, right?
Those big, super complex copiers
machines, those are typically leased.
Um, you may have some kind
of interest over time, uh,
for a product that you have.
So maybe it's this a million
dollars and they wanna finance
it, and so they may not.
You may not finance it as traditional
finance, meaning through a, a
loan, but you may say, alright,
instead of paying a million dollars,
uh, this year, we'll charge you,
um, $250,000 for the first year.
But we'll also add, add an interest
fee, um, for the remaining seven 50.
Then you pay two 50 every year
for the next four years plus some
type of, uh, interest, right?
Uh, there's licensee licensing, which
is what I described before, could be
some kind of patent licensing, could
be a product or some kind of IP that
you have that you can give away or, uh,
allow others to use it and they pay you a
licensing fee and then also commissions.
So anyway, all of those.
One, two or three of those you could
take because you're not in the consumable
business, you're not in food, but maybe
you have a product or a service that
could be tied to a consumable and then
you can get recurring revenue that way.
You guys know what I'm talking about.
You guys can figure it.
Right.
Um, and then when we're
thinking about, um, easy to
understand, easy to buy, right?
One thing to be thinking about wi
with that is that, um, when we're,
when we're building something
that's recurring revenue, um, and we
think about, let's go to the Keurig
example, that's a great example,
is the machine takes a Keurig cup.
Um, and if.
You wanted to buy a mini filter
and put some grain, right,
some ground bean in there.
Um, that's not gonna work, right?
So what it's done is it's created
a stickiness around your value
for quick, uh, easily consumed
coffee has a consumable, you
have to keep buying the cups.
Um, but now over time is,
it's inconvenient for me.
As the, the consumer to,
uh, want to switch, right?
Because now I'd have to go buy a
new machine or I'd have to go buy
a different, uh, uh, traditional
percolator type, uh, coffee maker, right?
And that's money that costs
me money to go do that, right?
And so now I'm kind of,
I'm kind of, um, wedged in.
And you don't wanna do
this in a, in a, in a, um.
In a, um, mean way necessarily, right?
But you're trying to create stickiness.
And so what you're doing is you're
creating a path through with the hardware,
the consumable, the end product, and you,
you're putting them into your ecosystem.
And as we know with large IT systems with
like Epic Healthcare Hospital System,
ERP systems is once you own those.
Uh, it's really hard to get out of that
ecosystem and switch to somebody else.
So anyway, um, that's, that's
some of the things that we use
to get to, uh, recurring revenue.
So ob these are obvious things, uh, coming
up, which is these can't be one time.
Value, right?
You can't just say, um, you can have these
in your business, but if you're looking
to build recurring revenue, if your
business is based on one time projects
with one particular customer, and then
you're done with that customer, you're
done with that project, and now you gotta
find another customer for another project,
that is not a model that's gonna create.
Lots of value for your asset, right?
A buyer's not going to add a lot of
value into that type of model, right?
Um, and as you grow, um, with
your reoccurring model, I
talked about this already, is.
You don't, you don't want it to
be more costly, meaning I need to
add more overhead, I need to have
more equipment in order to scale.
Um, I want it to, as, as I go,
exponential with my growth.
I also want my profit to also
increase as, as, as that's going
all around the reoccurring revenue.