Simple Sensitivity Model: 1-Year vs. 3-Year Contract
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The purpose of this model is to inform contract structuring and what you're gaining or giving up by selling a 1-year vs. 3-year contract.
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ProsCons
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Single-Year Contract- Faster sales process
- Retain expansion opportunity
- Presents greater potential churn risk
- Greater burden of ROI proof to justify next year's purchase
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Multi-Year Contract- Receive all cash upfront
- Customer lock in provides greater revenue predictability
- Limits expansion opportunity
- More negotiating required (heavier procurement process)
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Drivers:
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Cell D17: ACV
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Cell D18: ACV discount for 3-year contract, paid upfront
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Cell E20: Anticipated revenue expansion for years 2 & 3 on 1-year contract
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Cell E24: Discount rate applied to calculate present value of future cash flows on 1-year contract
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Note: You can run a goal seek to have equal present values for 1-year with expansion and 3-year contracts to determine either the discount you grant or back into expansion required.
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Cash Received
Year 1Year 2Year 3
3-year Gross
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Cash Received From 1-Year Contract Without ACV expansion
$300,000$300,000$300,000$900,000
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ACV Discount For 3-Year Contract
25.00%25.00%25.00%
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Cash Received From 3-Year Contract (100% received Year 1)
$675,000$0$0$675,000
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ACV Expansion Rate For 1-Year Contract
10.00%10.00%
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ARR From 1-Year Contract With ACV Expansion
$300,000$330,000$363,000$993,000
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Present Value (time value of money)
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Discount Rate For 1-Year Contract
25.00%25.00%
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Present Value For 1-Year Contract Without ACV Expansion
$300,000$192,000$153,600$645,600
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Present Value For 1-Year Contract With ACV Expansion
$300,000$211,200$185,856$697,056
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Present Value For 3-Year Contract without Opportunity For ACV Expansion
$675,000$0$0$675,000
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You can leave questions/thoughts/improvements as comments or email me at bparks@bigfootcap.com
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