Venture capitalist Tony Tjan believes that not all revenues are created equal. Companies that pursue growth of any kind and at any cost will have a difficult time achieving long-term value, according to Tjan, vice chairman of investment advisory firm Parthenon and general partner at VC firm Cue Ball. Instead, he looks for companies that have what he considers “hiqh-quality” revenues, as these are better indicators of long-term value.
In Tjan’s model, high-quality revenues have three characteristics:
1. They are predictable. Tjan’s VC firm looks for companies that are able to retain at least 90 percent of their customers from year to year, spending at least the same amount of money. With this degree of retention, it becomes easier to project revenues and cash flow over the long term, which increases company value.
2. They are profitable. More businesses need to take the time to analyze the profitability of their various products, services and clients. These should be divided into high and low profitability. Resources should be focused on growing the higher profitability revenues. This may sound obvious, but many small businesses fail to do this, opting instead to look at overall profitability from month to month or year to year. Tjan’s firm looks for companies that have at least a 70 percent gross margin overall.
3. They are diverse. Revenues concentrated in a few clients can be very risky; losing one key client could take down the entire company. Tjan believes that it's best for none of your top five clients to represent more than 15 percent of your overall revenues.
Read the full article at Harvard Business Review.
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