Recurring Revenue Is Overrated

April 22, 2022

by an investor from University of Texas at Austin in Austin, TX, USA

This is going to be a controversial take for most folks on here. Recurring Revenue is nice, but it's not the silver bullet it is made out to be. Purely focusing on recurring revenue businesses causes several issues for searchers that I write about in this week's post on Buy Small Sell High: Recurring Revenue Is Overrated

1. Truly recurring revenue businesses (mission critical / government mandated software or service) are rare, highly sought after and almost always trade for multiples searchers can't pay - we saw a $700k SDE HVAC deal trade for 8.25x SDE.

2. Recurring revenue businesses are generally recession resistant but not recession proof. Great Think Like An Owner Episode on that here.

3. If your customers are sticky, then so are your competitors'. Short of significant white space, these businesses are harder to grow organically, which is why we see so many roll-up strategies in those industries.

4. Recurring revenue is a proxy for the real metric everyone is looking for: predictable cash flows. There are other businesses that have predictable cash flows without recurring revenue driven by reordering trends, industry demand and position, etc. These are harder to prove since they required in-depth diligence, but also offer significant upside as the quality of the business is not apparent to everyone.

Reply by a professional
from Franciscan University of Steubenville in Denver, CO, USA

Sharing my own battle wounds on this topic. I opted to acquire an non-recurring revenue company at lower multiple and the business was relied on a B2C salesforce. The intent was to add a B2B channel post acquisition. We experienced turnover post-close and we were constantly trying to replace sales people to keep the B2C pipeline full while trying to grow the B2B channels. In future acquisitions this is something that I will never take a chance again on. If something goes wrong, ie turnover, covid etc is very hard to dig out of the hole.

Reply by a professional
from Harvard University in Atlanta, GA, USA

I agree with your overall point. Predictable cash flow is the umbrella metric and we love the few companies that have it in the form of "recurring" or "contractual" repeat business but long term customers - say over 3 years or so - should fit in this bucket too IMO. And "recurring" us too narrow a target for most searchers to find. Therefore, focus on predictable cash flow ^redacted‌

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