When an acquirer is considering buying your business, they’re going to want to understand how the business is going to generate sales when you, the owner, leave it.

Simplistically, there’s two types of revenue: one off transactional sales, and recurring revenue. Money that you know will come in.

And the more recurring revenue you have, the lower the risk for the buyer, and the more valuable your business is going to be.

Let me share seven different forms of recurring revenue with you. And I’ll explain why buyers view each of them differently.

I’ll share them in in reverse order, from least valuable to most valuable.

The bottom rung of the ladder is the simple consumables model. For example, in one of my own businesses, we sell horse supplements. The owners gives them to the horse daily, and people buy them again and again.

Next, moving up the ladder one step, is the sunk-money consumables model. The classic example here is Nespresso. You buy the machine and then you buy the small capsules that go with it. In the sunk money model, your switching costs are higher, so you’re more likely to remain loyal to the brand.

Then we come to subscription revenue. If you’ve ever subscribed to a magazine or a newspaper, you’ll know this model. There’s a start day and an end-date. And the editor or the owner knows what money’s coming in one to two years in the future.

Next up, sunk-money subscriptions. This is where you sink money into a platform or an asset, and then you buy access to information or a service through that platform. For example, investment banks buy Bloomberg terminals, that’s the physical computer that sits on their traders’ desks. They also buy information from Bloomberg on a subscription basis that gets delivered through those terminals.

Moving further up the ladder: Auto-renewal consumables is the next rung. So instead of having a start and stop date, the subscription continues in perpetuity. So, for the horse supplements I mentioned earlier, we offer customers an open-ended subscription. Basically, we’ll keep billing you and delivering your herbal supplement on a certain day every month until you tell us to stop. Another simple example of this is Netflix.

One step up from auto-renewal is “auto-renewal with removal”. This is where the customer is on an auto-renewal contract but has to move or remove something to be able to switch to another supplier. SalesForce.com is a great example. You’ve got all your data locked into their system and switching it is time consuming, costly and risky.

But the top of the ladder is contract revenue. Which is where a customer is contractually obligated to buy from you in the future. And that, of course, is the most secure form of recurring revenue.

So, to improve your score on this attribute, what you want to try and do is to climb up the rungs of the ladder. If you’ve got a consumable product, you want to try and get people to subscribe to buy it regularly. Then you want to try and get that on auto-renewal. If you offer a service, you want to productise it, and then work your way up the ladder.

Once you get as far up the hierarchy of recurring revenue as you can, you want to try and increase the share of your sales that comes from recurring revenue.

So, the higher up the ladder you go and the greater the proportion of your sales that come from recurring revenue, the more valuable your business will be.

5 Hierarchy of Recurring Revenue