How important is recurring revenue to your search?

searcher profile

November 23, 2020

by a searcher from Harvard University - Harvard Business School in Houston, TX, USA

We have spoken to a number of searchers and mentors on the topic. To some, recurring revenue is a must and any businesses without it needs to be discarded. To others, recurring revenue is a nice to have but not a deal breaker. Some people argue its more than worth it to pay for the higher multiples while others see EBITDA multiples above 5 to be scandalous. We have also heard (and personally experienced) some banks won't even take a second look at you if you only have project-based work.

Would love to hear the community's thoughts on the subject!

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commentor profile
Reply by a searcher
from Harvard University in Houston, TX, USA
I agree with everyone's general sentiment in regards to recurring revenue. Specifically, we try to look for businesses with at least 30% recurring revenue (contractual) that also have opportunities to increase that number. One thing we found is that even with contract-based recurring revenue you have to be careful when evaluating a business. Many contracts give very little power to the supplier and can be easily terminated by the purchaser (with a 30 day notice for example), which makes that recurring revenue much less safe. This year is probably a good test for many types of recurring revenue as you can get a much clearer idea of how easy it was for customers to drop out. Checking the recurring revenue portion of a company's income statement across several years is a must.
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Reply by a searcher
from New York University in New York, NY, USA
Recurring revenue is generally viewed on a spectrum with: contractual recurring (customers are bound to receive a service), then non-contractual recurring (mostly subscription-based businesses), followed by repeat (i.e. consumable businesses), and then project-based. There are other definitions but generally those are the big categories.
Contractual is the most attractive but not necessarily the most important when assessing an opportunity as one needs to think about the strength of the industry as well. A pure-project based business may be more attractive in a very fast growing industry compared to contractual revenue in a declining industry. Generally though, the search fund world tends to avoid project-based businesses due to the lack of experience of the searcher.
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