From: alexhormozi
A business’s value is significantly influenced by its ability to generate reliable, recurring revenue and retain its customers. This creates a compounding effect on growth and reduces risk for investors.
Understanding Business Value
The value of a business is primarily determined by three variables:
- Increasing the number of customers [02:02:00].
- Increasing Lifetime Gross Profit: This refers to the total profit generated from customers over the duration of their relationship with the business [02:09:00]. This means making customers worth more [02:22:00].
- Reducing Risk: This involves assessing the likelihood of the business’s continued operation and growth into the future [02:30:00].
All three variables contribute to a business’s “Enterprise Value” [02:40:00]. The lower the perceived risk, the higher the overall value of the business [02:51:00].
Reliable Recurring Revenue
Reliable recurring revenue is crucial for a business’s growth and valuation. Unlike traditional businesses where revenue resets each month, a recurring revenue model allows for continuous compounding [02:50:00].
For example, if a business acquires a customer worth $1,000 in month one and they continue to pay, and then acquires another in month two who also continues to pay, the total revenue compounds over time [02:50:00]. Businesses that plateau often do so because they sell the same amount of one-off products or services each month, with no compounding effect [02:26:00].
The ideal scenario is achieving “net negative churn” [03:07:00]. This means that even if no new customers are acquired, the business still makes more money each month because existing customers become more valuable or expand their services [03:11:00].
Example: Salesforce
Salesforce, a company valued highly, demonstrates net negative churn. They may lose a few customers, but the remaining customers grow their usage (e.g., more seats, email contacts, or revenue flowing through the software), leading to increased value and revenue for Salesforce [03:17:00]. Their business model is designed to align customer outcomes with their own, allowing them to continually grow with their existing customer base [03:34:00].
Consumer businesses like Netflix often focus on preventing cancellations, while B2B businesses, with fewer customers, aim for more expansion revenue opportunities [03:09:00].
The Nine Cs of Recurring Revenue
To increase how “sticky” a recurring revenue stream is, consider these factors [03:41:00]:
- Consumption: Are customers actively using the product or service they are paying for? [03:43:00] (e.g., gym memberships [03:33:00]).
- Collateral: Does the business hold something valuable that makes it difficult for customers to leave? [03:41:00] (e.g., storage units holding possessions, payment processors holding customer data [03:41:00]).
- Cost of Switching: Make it difficult for customers to leave by providing so much value they would lose significant benefits upon cancellation [03:00:00]. This can include social ties within a community [03:10:00].
- Choice: Limit other available choices for customers, possibly through patents or trade secrets that make your offering unique [03:19:00].
- Control of Money Flow: In B2B scenarios, controlling how money flows (e.g., processing payments) creates significant leverage for customer retention [03:32:00].
- Cause: Aligning with charities, movements, or values can create an identity connection, making customers more likely to stay [03:53:00].
- Community: A strong community around a product or service increases stickiness [03:05:00] (e.g., discussions around a show like “Stranger Things” [03:19:00]).
- Contracts: Formal commitments like 12-month memberships make revenue stickier than month-to-month arrangements [03:30:00].
- Communication: Regular communication with customers, such as informing them about upcoming events or new content, reduces churn by giving them something to look forward to [03:42:00].
Operational Elements Supporting Recurring Revenue
Several foundational aspects of a business enable consistent growth and strong recurring revenue:
Leadership Team in Place
For a business to be a valuable asset, it must be able to operate and grow even in the owner’s absence [03:12:00]. Many small businesses are essentially high-paying jobs for the owner, not transferable assets [03:33:00]. A strong leadership team, especially an experienced operator, reduces risk for potential buyers [06:06:00]. The true test of a good operator is if you, as the owner, gain more time and bandwidth [06:56:00].
Marketing Without the Founder
If the founder is the face of all marketing efforts, their departure poses a significant risk to future customer acquisition [01:13:00]. Businesses should transition marketing to other team members to create an independent asset [01:32:00]. This transfer of brand association takes time (e.g., 12 months in one case study) [01:52:00]. While a personal brand is valuable, it should ideally be separated from the primary source of business income if the goal is to sell the business [01:40:00].
Delivery Without the Face of the Founder
Similar to marketing, if the founder is key to service delivery or customer relationships, their absence creates a risk factor [01:10:00]. Instead of finding one person to replace the founder, it’s often more effective to distribute responsibilities among multiple “subject matter experts” who specialize in different areas [01:56:00]. These individuals should be empowered and possibly given equity to incentivize their long-term commitment [01:53:00]. This directly impacts the risk factor within the business, as an investor will only pay for future value if it does not require the founder’s direct involvement [01:43:00].
Multiple Reliable Acquisition Channels
Reliance on a single customer acquisition channel (e.g., Facebook ads, YouTube content, outbound emailing) presents a significant risk [02:30:00]. Diversifying into multiple channels makes the business more stable and increases the number of customers, thereby increasing value [02:19:00]. This requires patience and focusing on “more and better” from existing channels before adding new ones [02:35:00]. Learning from customer interactions and progress over outcome are key when expanding channels [02:50:00].
Diverse Customer Base
A business heavily reliant on one or a few large customers (“whales”) is inherently risky [02:24:00]. If that key customer leaves, it can decimate profit, even if they only represent a fraction of total revenue [02:51:00]. Ideally, no single customer should account for more than 20% of revenue, and ideally less than 5% [03:06:00]. This diversification reduces risk for buyers [03:22:00].
Automated Metric Tracking
Data-driven decision-making is critical for growth [04:17:00]. Implementing CRMs and dashboards allows for real-time tracking of metrics, which is essential for understanding customer acquisition costs, lifetime gross profit, and overall business health [04:08:00]. Without clear metrics, businesses are often guessing, making it impossible to identify bottlenecks or measure improvements [04:52:00].
High Cash Flow, Profitable, and Growing with a Good Story
Investors prefer businesses that are already in motion and growing [04:49:00].
- High Cash Flow: The business generates cash in excess of what’s needed for reinvestment and growth [04:59:00].
- Profitable: The business earns more than it spends [05:06:00].
- Growing: The business consistently increases in size month over month or year over year [05:22:00].
- Good Story: A compelling narrative, often linked to industry trends (e.g., AI integration), can attract investors and demonstrate future growth potential [05:28:00].
Founders should consider taking a fixed amount of cash out of the business monthly to de-risk themselves, even if it means sacrificing some growth [05:11:00]. This is part of building a sustainable business model.
Audit-Ready Financials
Having verifiable financials is crucial for selling a business [05:47:00]. “Audit-ready financials” mean a third party can validate the stated profit [05:57:00]. This provides a “blue check mark” of legitimacy for investors [05:29:00]. Moving from cash-based to Generally Accepted Accounting Principles (GAAP) accounting provides a smoother, more accurate view of financial performance over time [05:53:00]. A lack of a robust finance function can lead to uncertainty and hinder growth decisions [05:58:00].
$5 Million+ in EBITDA
Most institutional investors prefer to acquire companies generating at least 2 million profit can grow to $9.4 million EBITDA in two years with the right strategies, dramatically increasing its valuation [06:21:00]. This is about unlocking value.
By focusing on these elements, businesses can increase their value, ensure long-term stability, and achieve significant financial returns.