Our software enabled services business has high customer retention but no long term written contracts, and the buy side is trying to price us as a project based firm. How do we use the Income Approach under IVS 105 to defend our recurring revenue valuation?

Question

Tyler Smith · Accepted Answer

Buyers love to use the absence of multi-year contracts as an excuse to apply a heavy discount, categorizing your recurring revenue as transactional or project-based. To defeat this argument, you must use the Income Approach, specifically the Capitalization of Earnings Method under IVS 105, to prove the stability of your cash flows.

The Capitalization of Earnings Method is highly appropriate when a business expects long-term, stable cash flows, using recent historical results as a reliable proxy for future operations. To defend your valuation, present the buyer with three specific data sets:

- A cohort analysis showing that despite the lack of long-term contracts, your average customer retention exceeds three to five years, proving high customer loyalty.
- Your customer acquisition cost to lifetime value ratio, demonstrating the long-term profitability of your client base.
- Your documented customer onboarding and success processes, showing that your automated service delivery model makes customer churn highly predictable and low.

Under IVS 105, the economic benefit of an asset is based on the expectation of future cash flows. By demonstrating that your historical cash flows are highly predictable and behave exactly like contractually recurring revenue, you can successfully argue against a transactional discount and protect your recurring revenue multiple.