When it comes to startups, there are two main types of business models- direct sales or subscription based model(s) and event sponsored products or services. The first type is selling directly to consumers or individual customers, while the second type is providing access to limited resources (products or experiences) in exchange for payment per use.
By most definitions, an event sponsorship is considered recurring revenue generation because you get paid over and over again for using their service. This article will focus exclusively on the latter - staying focused solely on the topic of event sponsored businesses!
Event Sponsorships as Business Model
Writing this article has been a lot of fun so far, but now we’re going to talk about what kind of business model event sponsorships are and how they work. I wanted to go into more detail than just saying “they pay to be featured during events”, so let’s dive in!
First, what is recurrence?
A recurrent transaction happens repeatedly with a fixed price each time. For example, buying a monthly magazine subscription or paying for yearly membership at a gym. Both of these transactions occur once a month or annually, respectively, and therefore the term ‘recurrent’ applies.
Companies that have recurring revenue typically use this income as their key success factor in growing their business. This is because they understand the importance of these revenues for the long-term growth of their business.
Recurring revenue comes back year after year, which makes it more stable than short term revenue. More and more people pay monthly subscriptions or yearly fees for services, such as Netflix or Amazon Prime.
These companies are able to grow due to the stability of these incomes. They know that every month or year someone will be paying them for their service, so they can invest in marketing materials, new technology, and other things to draw in new customers.
Valuing a company based on its annual recurrece revenue is an important part of investing. If you’re looking into acquisitions or starting your own business, knowing how to value a company based off of ARR is one way to make sure you don’t overpay.
Here's what you should know about valuing a company based on ARR.
In the recurring revenue business, there is one more piece of information you need to know before calculating your company’s valuation. This is the “average ANNUAL SALARY” or AAV for short (we will use AAV in our calculations).
The AAV is simply the total amount of money an employee makes divided by the number of months in a given period. So if An Employee Makes $5,000 per month, then the AAV would be 500, as the year comes out to half a year!
If we were doing this calculation for the monthly salary, then the AAV would be 12,000, because it divides up into twelve months.
However, when determining the value of a business with recurrent revenues, we must also take into account how much each employee is paid ON AN ANNUAL BASIS, not just a monthly basis.
In step two, we multiply this value by your projected growth rate for the business. The easiest way to do this is using Google’s free tool: https://wwwinfo.longhardware.com/business-valuations/calculate-market-value-businesses/
Use their calculator to determine how much money you would make in the next year if the company was able to continue its current level of revenue production forever.
By doing this, you are determining what the market could be paid right now for the company (the present value) and then multiplying that number by one additional year to get the total market valuation.
In step three, we multiply this value by our adjusted gross profit (AGP). The AGP is simply your total revenue less costs to produce that product or service. For most businesses, this will be their monthly recurring revenue (MRV), which is how much money they make every month from a steady source of income.
For example, if you run a food truck business, then your MRV would be the amount per meal sold multiplied by the number of meals you prepare each week. If you do not include the cost of fuel in your price, then your AGP becomes effectively zero! This makes sense because you are spending those resources constantly, so there is no effect due to lower levels of investment.
By adding all these individual expenses together, you get your overall company overhead, which includes things like rent, employee salaries, etc. We can assume here that the rest of the companies’ budget is already accounted for, so these additional costs do not matter too much. Therefore, this value gets reduced slightly.
The final value in steps four and five comes directly after adjusting for overhead. It is referred to as adjusted gross profit, and it represents the profitability of your business. By subtracting overheads from revenues, we create an efficient way to measure the health of your business.
In step four, we calculate how much revenue an app will generate in one year to determine its annual recurring revenue (ARR) value. To do this, we use the equation mentioned above multiplied by the ROI of the app.
The numerator is calculated using the formula:
Numerator = Monthly App Revenue - Cost per month
To find the cost per month, you need to know two things: The monthly subscription price and the length of time it has been running as a paid service. For the denominator, we use the average monthly income for your top performing apps to create a baseline. Then, we add onto that number all past costs!
This way, our final calculation accounts for all underlying expenses related to the app such as marketing, research and development, etc. By adding these additional costs into the equation, we can arrive at a more accurate ARR valuation.
In step five, we need to multiply this number by a contingency. A common way to do this is to use the equation: EQUITY/ROLL-OUT PRODUCTIVITIES x NEGATIVE COVERAGE CYCLES = CONTINGENT VALUE
The equity portion of this equation refers to how much money you expect to make from the business when it is in its most productive state. This is referred to as the company being profitable or achieving roll-out productivity. The productiveness can be adjusted for if the business is not yet fully run down (recession) or if it is going through significant changes (technology shifts).
By adding technology into the mix, we lose the efficiency of using past methods and have to rework the production process. For example, if your business is making and selling yoga mats, then including the effects of new technologies like plastic sheets would costage the profitability of the business. If we were to include these costs in our valuation, the price of the mat would go up due to this factor. By factoring in a discount for this, we can calculate the contingent value.
This discounts the final value because there is risk involved in investing in the business. Due to the potential loss in investment, people are willing to pay less for the shares.
In step six, we multiply this value by 1-2 months of annual recurring revenue to determine how much our company is worth.
We can also refer to this as an “annualization” or “arithmetic average” method because we are taking the current market price of the business and multiplying it by what the business would be in twelve months (the length of time it takes for most businesses to fully recoup their investment). This way you get a more accurate picture of what the business is actually worth since it factors in its future growth.
This calculation assumes that the market will not accept your business as worth less than what it is now so there is no need to discount for lack of earnings.
In step 6, we calculated how much revenue you expect to get in the future from your business. Now it’s time to calculate how much that revenue is worth now! This is referred to as an internal rate of return (IRR) calculation.
The internal rate of return (IRR) calculation compares the cost of owning the asset (in this case, your business) with the income the business can generate. More specifically, it calculates what percentage of the asset’s value you would have to sell your business for it to make a loss. A loss means you spent more money to own the company than what it was sold for- in other words, you made a bad investment!
So, let’s do some numbers! If your projected ROI equals or exceeds 20%, then your business is clearly not making enough profit currently and should be considered investing opportunities rather than purchases.
A lot of entrepreneurs struggle with their IRB calculations because they use inefficient metrics such as monthly net revenues instead of annualized ones. When calculating the price of a business, you must also include costs of ownership such as rent or office space. You should assume that the going rental rates are constant over the next year and add this amount to buy down on the business valuation.