Sunday, February 23, 2014

What should be the target renewal rate?

Every company with recurring revenues knows that the renewal rate is important.  Usually, the VC board member constantly pushes for a higher renewal rate.  But, what should be the target renewal rate?

I try to answer this question in two ways.

1) Impact on Revenue Growth.  Assuming the same new business growth rate (ie 40%), revenues after 10 years will be just 1x with a 60% renewal rate, 12x with a 89% renewal rate and 23x with a 97% renewal rate.  The underlying chart shows the revenue growth tied to various renewal rates assuming a 40% new business growth rate.

2) Impact on the Valuation/Revenue Multiple.  Public companies with a 89% renewal rate have revenue multiple of approximately a 3x, while public companies with a 97% renewal rate have a multiple of approximately a 14x.

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