How to Value a Subscription-Based Business
Subscription-based business models don’t fit traditional valuation methods. These businesses include services like home or vehicle maintenance, gym memberships, and streaming services. For small business owners looking to sell and for prospective buyers looking to acquire these types of companies, understanding their unique value proposition is essential. Since they often have steady income and predictable growth, subscription business valuation requires a different approach to. We break down the key metrics and methods used to determine a subscription company’s true market value.
Key Metrics for Subscription Businesses
These numbers help you measure the success of a subscription business.
- Monthly Recurring Revenue (MRR): This is the steady income you earn each month from active subscriptions. It shows your business’s health and helps predict short-term growth. For example, if 200 customers each pay $70 per month, your MRR is $14,000.
- Annual Recurring Revenue (ARR): This is the yearly income from subscriptions. You calculate it by multiplying MRR by 12. ARR is important because investors and buyers look at it closely when evaluating acquisitions.
- Customer Lifetime Value (CLV)This measures how much revenue a typical customer generates during their entire time with your business. To find CLV, multiply the average revenue per customer by the average customer lifespan. For small businesses, a high CLV indicates strong customer loyalty and potential for stable returns.
- Customer Acquisition Cost (CAC): This shows how much it costs to get a new customer. It includes marketing and sales expenses, divided by the number of new customers. Keeping CAC low ensures you’re not spending more to attract new customers than they are worth. When buying a subscription business, examine if CAC has been rising or falling over time.
- Churn Rate: Measures how many customers cancel their subscriptions within a given time. A high churn rate may mean customers are unhappy or prices are too high. A low churn rate means customers are satisfied. Main Street business buyers should be especially wary of businesses with increasing churn rates.
Valuation Methodologies – How to Value a Business
Here are the main ways to determine the value of a subscription-based business.
- Revenue Multiple Method: This method multiplies your annual recurring revenue by a factor, usually between 2x and 6x. The exact factor depends on how strong and profitable your business model is. Subscription services with steady growth and successful cross-selling often get higher multiples. For small business acquisitions, multiples typically range from 2-4x for stable businesses.
- Market, Asset, and Income Approach:
- The market approach compares your business to similar ones that have sold recently.
- The asset approach adds up the value of everything your business owns, like equipment and customer lists.
- The income approach estimates future earnings from subscriptions and upgrades.
- Discounted Cash Flow (DCF): This method calculates the present value of expected future cash flows. It factors in subscription revenue trends, customer retention rates, and subscription pricing strength. Businesses with stable recurring fee structures benefit most from this approach.
- Combining Valuation Methods: Using multiple methods gives a clearer picture of both current income and future potential. It also helps assess customer lifetime value, upselling opportunities, and overall business model performance.
Value Drivers
Not all subscription business models are worth the same. These key areas show why some are worth more than others.
- Growth Rate: This shows how quickly a business adds a new customer base and sells more to current ones. Businesses with faster growth in recurring payments are usually worth more, especially in software-as-a-service (SaaS) markets. For small business buyers, sustainable growth of 10-25% annually is often preferable to unsustainable hyper-growth.
- Customer Concentration: This checks how much risk comes from relying on a few customers. A business is more stable if no single customer makes up more than 5% of revenue. Buyers should be particularly cautious of businesses where the top 10 customers represent more than 30% of revenue.
- Contract Length/Terms: Longer contracts and auto-renewals make a business more valuable. Multi-year deals, such as streaming services, show strong customer relationships and predictable revenue.
- Scalability: This measures whether a business can grow revenue without a big increase in costs. A scalable pricing model can serve more customers with minimal extra expenses. Buyers should look for businesses where operational processes are well-documented and automatable.
- Market Position: This looks at how strong a business is in its industry. Strong brand recognition and few competitors are worth more. Factors like market share and competitive barriers play a role.
Industry Benchmarks
The value of a subscription business also depends on the industry. Software subscriptions usually make higher profits and sell for more. Meal delivery services have smaller profits and sell for less. These industry trends help set expectations for what your business might be worth.
Market comparables look at similar businesses that have sold recently to get a good idea of what buyers are willing to pay. Businesses in the same industry, of similar size, and with similar customers would provide useful comparisons.
Location can also affect a business’s value. A subscription business in a big city might be worth more than one in a small town because it has more potential customers. However, online subscription businesses can reach people everywhere, so location may not matter as much, making them particularly attractive for small business buyers with limited geographic reach.
Assembling a Team
Getting an accurate valuation and selling your subscription business requires expert help. A business broker who knows the subscription market can provide valuation expertise, find the right buyers, and guide you through the sales process. An accountant can organize financial records and highlight your business’s true earning potential. Lawyers provide legal guidance and ensure contracts, subscription agreements, and intellectual property are properly transferable.
Hiring professionals might cost some money upfront. However, they can help you sell your business for a higher price and avoid costly mistakes during the process. Visit BizBuySell’s Business Broker Directory to find a broker to help you sell your subscription-based small business.