Why it matters
Revenue won through deep discounts is worth less than revenue earned at normal prices. A seller who wants a strong final year has several ways to produce one: cutting prices, running constant promotions, selling annual plans at a steep discount for payment upfront, or pushing extra stock onto distributors and retailers with generous return terms. Revenue, or at least cash, rises. Margin, future sales and the quality of the customer base usually suffer.
When you buy, you inherit customers who expect those prices. Raising prices later may lose many of them, and the growth that justified the price goes with them.
Discounted prepaid deals cause a second problem. The seller collects a year of cash now, and you deliver the service after completion with little new income from those customers (see customer prepayments already spent). Stock pushed onto resellers tends to come back as returns, or as smaller orders in the months that follow.
Loupe's valuation tool compares the last 12 months of revenue with the 12 before. At its starting settings, growth of 5% to 20% adds 5% to the multiple and growth above 20% adds 10%, while a fall of 5% to 20% takes 10% off. Discount-led sales can move a business from a reduction to an increase. Work out the trend with and without the promotional revenue before you rely on it.
How to spot it
- Gross margin is falling while revenue rises.
- The average selling price or order value has dropped.
- Revenue jumps at the end of quarters or in the months before the business was listed.
- The ecommerce platform or advertising accounts show more discount codes and promotions over time.
- A growing share of customers has moved to annual prepaid plans in recent months.
- Receivables, or stock held by distributors, are growing faster than sales.
- Returns and credit notes rise just after a period end.
Gross margin is revenue minus the direct cost of what a business sells, shown as a percentage of revenue. It shows how much each sale contributes towards overheads and profit.
Questions to ask the seller
- What discounts, promotions and special terms have you offered in the last 24 months, and what share of revenue came through them?
- What was the average selling price in each month of that period?
- Did customers who first bought on a promotion come back at full price?
- Have distributors or retailers taken more stock than usual, and on what return terms?
- What would revenue have been without the largest promotions?
Documents to request
- Monthly sales for the last 24 months, showing list price, discounts and net price separately
- Monthly gross margin for the same period
- Price lists and discount policies in force over the period
- Distributor and retailer agreements, including returns, rebates and payment terms
- Returns and credit notes issued in the months after each period end
- Repeat purchase or renewal rates for customers acquired through promotions