Transforming Implementation Revenue into Software Revenue:
A Strategic Overview for Software Founders
For software companies, especially those aiming for the enterprise sector, the classification of revenue can significantly impact valuation and investor appeal. Many founders grapple with a common issue: their revenue is often categorized as service revenue due to implementation fees, which is perceived as less valuable than software revenue. But, as a founder, you know the implementation has to happen, and especially in the early days, it can be almost impossible not to take it on. So then what?
This post offers a strategic approach to restructuring your revenue recognition to favor a SaaS model. It’s a high level guide based on our experiencing seeing multiple founders successfully execute this path–and it’s pretty generic, so as you read along, adapt to your unique circumstances.
Step 1: Develop a Certified Partner Program
Create a program where third-party service providers can become certified partners. This initiative allows your company to transition from directly offering services to overseeing a network of trusted providers. By doing so, you can shift the focus of your revenue from services to software. Start small. Beginning this process can seem daunting at first, but it’s one of those things that pays triple dividends in better, more scalable sales processes.
Step 2: Establish Contracting Models with Partners
As you dig into starting that certified partner program, work closely with your certified partners to develop standardized contracts. These contracts should ensure that your company only recognizes the gross margin of the service provided, rather than the full service revenue. This approach aligns more closely with the revenue recognition of SaaS models. Many founders push back a bit here, saying that the income from services is a meaning part of their cash flow–but that is actually a false impression. If you are paying others to do services for you, you’re paying others–cash in, cash out is not actually valuable and in fact is also a friction on your business. Simplification of software sales is the best path to building a valuable company that investors, or strategics, will pay top multiples for.
Step 3: Integrate Service Contracts with Software Sales
Ensure that service contracts offered by your partners are always coupled with your software contracts. This integration helps in maintaining consistency in service quality and pricing, further solidifying your company’s role as a software provider rather than a service provider. To do this well, you’ll want to discuss with your current investors or board, speak with a founder or two who has done it, and get your business attorney involved. Every company has a unique “stapled contract” approach–this is one of those areas where you do not want to reinvent the wheel. Fortunately, there is a whole set of “these wheels” in market for you already, in the form of stapled contract examples.
Step 4: Set Clear Performance Standards
Implement service-level agreements with your partners. These agreements should outline performance expectations and quality standards. Meeting these standards is crucial for partners to maintain their certified status, ensuring consistent quality for your clients. As you professionalize, you’ll review these SLAs on a cadence to make sure they reflect your dynamic and growing business.
Step 5: Resell Partner Services A
dopt a reseller model with your partners. Under this model, your company earns a commission from the services sold by the partners. This commission should be structured in tiers based on contract values, aligning your revenue more with a SaaS model. This is another way you underscore the centrality of software as the heartbeat of your business.
Step 6: Adhere to Industry Norms for Commissions
While setting up commission structures, stay within the industry norms. Although the commission might be less than the gross margin, it aligns your revenue structure more closely with that of a SaaS company, which is significantly more valuable from an investor’s perspective. For most companies, services revenue is valued, at most, at 1X (and often far below that). Software revenue is valued at multiples per year, depending on your churn and growth rate–it’s where your hard work as a founder and team can really pay off with generational wealth.
Step 7: Incentivize Lead Generation
Offer additional incentives for partners who generate leads for your software products. This strategy not only boosts your software sales but also strengthens your ecosystem of partners. You’ve seen this before–the user conferences you’ve been to in adjacent industries, or your own, often feature incredible conferences built around just these sorts of incentivized networks.
Step 8: Choose Your Role in Payments Carefully
Decide whether to act as a paying agent for services rendered by your partners. It’s generally advisable not to become a paying agent, as it could obligate you to recognize the full value of the service contract as revenue. Instead, facilitate direct payments between clients and partners, aligning your revenue recognition more with a commission-based model.
Transforming your revenue structure from a services-dominant model to a SaaS-dominant model requires strategic restructuring and careful planning, but it’s incredibly rewarding. You’ll want to engage your accounting team and your attorney as you craft your own approach over time, because as you scale, the intricacies of SaaS and A revenue recognition can get quite complex (see KPMG for example). By implementing a certified partner program and aligning your contracting and commission models accordingly, you can significantly enhance the valuation and appeal of your software company in the eyes of investors and potential buyers.
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Are you building this out for yourself and looking to raise a seed round in the South? Perhaps Valor can help. Please consider sharing your revenue story with our investment team.