The Key to Small Business Acquisition Success.

Since 1996, the Center for Entrepreneurial Studies at Stanford Graduate School of Business (GSB) has conducted a study of search funds every 2 years. A search fund is an entrepreneurial path undertaken by one or two individuals who form an investment vehicle with a small group of investors to search for, acquire, and operate a private company for six to ten years. There are plenty of ways to buy a business and by no means is the search fund model the only way, but the search fund study conducted and updated every other year by GSB is great study material for any business buyer looking to acquire and operate small companies.

The Key 🔑 Revenue Deja Vu.

Despite spanning a range of industries, many of the businesses acquired by search funds share some qualities, such as strong growth and, most notably, recurring or repeat revenues.

Recurring revenue is revenue that is collected via regular monthly or quarterly payments, or annual payments for services received every month or quarter. High recurring revenue is when 65% or more of the revenue is recurring.

When I was looking to acquire my first company in 2016 at 26, I read the GSB study from 2016. The data at the time demonstrated a clear positive correlation between company performance and recurring revenue. Over 70 percent of the search funds that produced a 2x to 10x ROI reported high recurring revenues. Only 10 percent of funds that incurred a partial or total loss were reported as having high recurring revenue. The sample size was not huge (55 companies), but the link between search fund success and recurring revenue was clear. In 2020 and 2021, 66% of companies purchased (and included in the 2022 GSB study) reported high recurring revenue.

Recurring revenue isn’t the only key to small business acquisition success, but it's a significant one and is the major reason why we focus on acquiring software companies with recurring revenue at Quadshift. The value of recurring revenue (coupled with high gross margins and infinite scalability) is a large reason why some software-as-a-service companies are so valuable.

‍