Case Study: The Power of Recurring Revenue When It’s Time to Sell

Most pest control operators understand that expanding their share of recurring revenue is a good idea, but few people have seen first-hand just how powerful recurring revenue can be when it comes time to sell a pest management business.

Dan Gordon has. In fact, the Managing Director of PCO Bookkeepers and PCO M&A Specialists recently shared a real-life example illustrating the difference having a high share of recurring revenue can make – and it’s not just about valuations. (Discussion begins at the 33:30 mark.)

Take a look at this example to see how being heavier in recurring revenue – even if profits are equal – can protect your company in times of economic uncertainty and when it’s time to sell.

Company 1 assumptions – before an economic jolt:

• Recurring revenue is 80 percent ($2.4 million), one-time revenue is 20 percent ($600,000)
• $3 million in annual sales ($250,000 per month)
• Net profit is 10 percent or $300,000 annually ($25,000 per month)
• 50 percent gross margin

Based on these assumptions, fixed costs are $100,000 per month ($250,000 revenue – $125,000 direct (50 percent) – $100,000 fixed (calculated) = $25,000 profit)

Company 2 assumptions – before an economic jolt:

• Recurring revenue is 50 percent ($1.5 million), one-time revenue is 50 percent ($1.5 million)
• $3 million in annual sales ($250,000 per month)
• Net profit is 10 percent or $300,000 annually ($25,000 per month)
• 50 percent gross margin

Based on these assumptions, fixed costs are $100,000 per month ($250,000 revenue – $125,000 direct (50 percent) – $100,000 fixed (calculated) = $25,000 profit)

Both Company A and Company B were pursuing a sale of their business earlier this year.

“As soon as COVID hit, our purchasers said, ‘We want a weekly update on sales because we want to see if we’re being hit hard,’” Gordon says, explaining that the buyers needed to know if they should reevaluate their acquisition offers.

As you can see, the only difference between the two companies above is the percent of recurring vs. one-time revenue.

What happens when there’s a major economic jolt?

An economic jolt may be a regular slowdown, a financial system meltdown like in 2008, a major geopolitical event like 9/11, or a global pandemic, such as COVID-19.

“When something hits really hard, your one-time work dries up pretty quickly,” Gordon says.

Continuing the example from above, let’s assume 80 percent of one-time work dries up and there are 10 percent skips on recurring accounts for both Company 1 and Company 2.

Company 1 assumptions – after an economic jolt:

• One-time revenue decrease of 16 percent (80 percent of $600,000 = $480,000 = 16 percent total decrease)
• Recurring revenue decrease of 8 percent (10 percent of $2.4 million = 8 percent total decrease)
• 24 percent total decrease ($720,000 or $60,000 per month)
• $250,000 monthly revenue – $60,000 = $190,000 monthly revenue
• $190,000 at 50 percent gross margin = $95,000 gross profit
• $95,000 gross profit – $100,000 fixed costs = Monthly loss of $5,000

The above scenario for Company 1 “hurts, but it’s not the end of the world,” Gordon says.

Company 2 assumptions – after an economic jolt:

• One-time revenue decrease of 40 percent (80 percent of $1.5 million = $1.2 million = 40 percent total decrease)
• Recurring revenue decrease of 5 percent (10 percent of $1.5 million = $150,000 = 5 percent total decrease)
• 45 percent total decrease ($1,350,000 or $112,500 per month)
• $250,000 of monthly revenue – $112,500 = $135,000 monthly revenue
• $137,500 at 50 percent gross margin = $68,750 gross profit
• $68,750 gross profit – $100,000 fixed costs = Monthly loss of $31,250

Company 2, with a $31,250 monthly loss, is in a much more dire situation than Company 1.

“This kind of loss could put you out of business,” Gordon explains. “This is a real example and this killed a deal we had. It put the company who was for sale in a really precarious position. They just had a deal on the table where they were going to sell their company for a whole bunch of money, and now all of a sudden, they can’t even make ends meet. They have to quickly try to reduce their fixed costs.”

While it’s tempting to chase larger, more profitable revenue streams, like one-time bed bug jobs or $100,000 bird jobs, industry experts urge pest control operators to focus on boosting their recurring revenue numbers for good reason, as this example shows.

“It’s that slow and steady growth of $100 quarterly accounts that’s going to build stability for weathering a bad day, and also for getting a higher valuation when it comes time to sell,” Gordon says.