THE QUESTIONS ENTREPRENEURS ARE ASKING: HOW TO BUILD VALUE
Most of our clients are entrepreneurs. When they ask questions, we listen. Then we keep track of recurring themes so we can answer those questions here. This is one of our favorites:
Are there steps I can take now to increase my value?
The software sector is young and dynamic. Buzzwords, technologies, and business models have come in and out of fashion. During the dot-com period, valuations were based on eyeballs. During the software boom, valuations were based on new, quarterly perpetual license sales. And during the initial SaaS boom, valuations were based on revenue growth. Adapting to the preference of today invariably means you will be out of step with tomorrow’s taste. However, over time, the software sector will align with traditional business models that have evolved over centuries rather than decades.
With this in mind, you will maximize the value of your business by working toward a business model that delivers:
- Recurring revenue that…
- Grows faster than the growth of your market, with…
- A gross margin that exceeds the gross margin of your peers, and also includes…
- Sustainable pricing and margins.
1) Recurring revenue
It’s hard to forecast perpetual license sales. Recurring revenue creates a stable, forecastable revenue base. While it is harder to win, it creates a more stable platform. That said, recurring revenue comes in different flavors. Some segments – for example, CRM, accounting software, and many vertical market software segments – support a simple SaaS subscription model. Other markets, such as AEC and GIS, have gradually moved toward a term license model, but have not proven suitable for a pure SaaS delivery mode. No matter how it is structured, the important thing is that the customer is conditioned – and ideally contracted – to pay an ongoing fee for ongoing use of the technology.
2) Growth rate
When you invest in the stock market, you want to measure success by whether your investment grew faster than the market indices. Acquirers look at opportunities in a similar way. If you are growing slower than your market, then you are falling behind.
3) Gross Margin
Gross margin is a great measure of the financial health of your business. If you are underpricing your solution or spending too much money on provision of services for your customers, the gross margin will tell the story.
4) Sustainable Pricing and Margins
Customers are dazzled by their first exposure to a product, but after using it for years, they expect the cost to go down – and in most markets, this perceived commoditization is exacerbated by increasing competition. Customers expect to pay less. If pricing is pushed down faster than cost, margins erode over time. You will need to innovate and create more value for your customers, if you plan on maintaining margins.
These are the four main factors you’ll want to take into consideration in order to maximize the value of your business. If you have follow-up questions, feel free to drop them in the comments.