A common conversation with clients revolves around whether they should show revenues generated through channel partners as a gross number (end user sales value) or a net number (after discounts, incentives, commissions or royalties have been accounted for). Since our definition of channel partner is pretty broad here - channel partner may be a dealer, distributor, value-added developer (VAD), value-added reseller (VAR) or a consultancy that serves as prime contractor - we should answer in broad terms. I've laid out some guidance that should help so that your revenue recognition is justifiable and defensible with buyers. As we know, if a buyer is going to base a valuation on a revenue multiple, then a larger revenue number will always win.
Booking Gross Revenues is generally appropriate if:
- The sales commission is subject to quantity discounts that are not known at the time of each individual sale or when revenue is known, for example: calculated quarterly and applied after the fact.
- The partner is paid a commission or royalty on each sale much like a company salesman, particularly when your company controls the end user price. The commission should show as COGS.
- If the revenue and/or cash flows around the partner to you.
Booking Net Revenues is generally appropriate if:
- The software license is sold to the partner at a discounted price as specified in the partner agreement.
- The licenses are inventoried by the partner/reseller. You shouldn't book revenues until later if the license can be sent back. (This is why many companies have been crucified.)
- The partner controls the end user license fee.
- If the license agreement is between the partner and the end user.
- If the license/software is embedded in a value-added deliverable by the partner that is then sold again under different commercial terms.
- If the invoice to the partner shows gross minus discount or commission and net revenue as amount due.
- If the revenue and/or cash flows through the partner to you.
Generally, buyers take a conservative approach, and will recast revenue that is not booked in a fashion consistent with their own practices. Further, your financials should reflect your business practice and the practice should be outlined in the partner agreements. We want to avoid a situation where we are exaggerating revenue or being inconsistent in our revenue recognition, as it can raise a red flag during due diligence.