Latest / The Buyer & Seller Podcast with Fexingo: Business Brokers, Exits, and Private Sales Explained / How a Small IT Firm Hit 40x EBITDA with Recurring Contracts
Transcript
- Lucas: So we talk a lot on this show about how recurring revenue transforms a business's exit multiple. But usually those stories are about subscription boxes or laundromat routes — physical, tangible stuff. Luna: Right. But the purest form of recurring revenue is probably in services — specifically IT managed services. Lucas: Exactly. And there's a case out of Austin that I think is the cleanest example I've seen. A 12-person managed IT services provider — think small-business IT support, network monitoring, help desk — sold earlier this year for 40 times EBITDA. Luna: Forty times? That's software-company territory. How did a 12-person services firm command that? Lucas: It came down to three things: contract structure, client concentration, and price escalation. The firm had about 80 clients, but no single client represented more than 4 percent of revenue. So the buyer saw zero key-man risk on the client side. Luna: That's smart. But what about the contracts themselves? Were they month to month? Lucas: No — and that's the critical detail. Every client was on a three-year contract with an automatic 5 percent annual price escalator. The contracts also had a 90-day termination notice period. So the buyer could model out at least three years of locked-in revenue, growing at a known rate, with a buffer to replace any client that did leave. Luna: Three-year contracts in IT services is unusual. Most small MSPs are month to month because clients don't want to lock in. Lucas: Exactly. The founder told me he lost about 20 percent of prospects during sales because of that requirement. But the ones who signed stayed. His retention rate was over 95 percent over the life of the business. Luna: So he traded volume for quality. That's a hard trade to make when you're bootstrapped. Lucas: It is. But it paid off. The firm's recurring revenue was 92 percent of total revenue. The remaining 8 percent was hardware resale and project work, which actually had higher margins because they marked up equipment 25 percent. Luna: So the buyer wasn't just buying a cash flow stream — they were buying a predictable, growing cash flow stream with a built-in inflation hedge. That's why the multiple got to 40x. Lucas: Right. And the buyer was a larger regional MSP roll-up platform. They already had 200 employees, so they could absorb this firm's clients into their existing help desk without adding much overhead. That's where the synergies came from. Luna: So the multiple makes sense in that context. The buyer wasn't paying 40x for standalone growth — they were paying for the client relationships and the contract book. Lucas: Exactly. The due diligence process actually took five months, which is long for a deal this size — sub-10 million dollars. But the buyer wanted to verify every single contract, every termination clause, every service-level agreement. Luna: What were they looking for specifically? I imagine they wanted to make sure the contracts were enforceable and not just templates the founder threw together. Lucas: That was part of it. But the bigger issue was the scope of services. Some contracts included unlimited remote support, others capped it at 10 hours a month. The buyer needed to harmonize those into their standard service tiers without triggering a renegotiation. Luna: So the contract complexity actually created a barrier to entry — or at least a negotiation challenge — for the buyer. Lucas: That's a great point. The seller had a very disciplined approach. He used a single contract template with three tiers: bronze, silver, gold. Each tier had clearly defined response times, coverage hours, and exclusions. There was no custom pricing. Luna: That's rare. Most small MSPs I've seen have clients on bespoke plans because they started by saying yes to everything. Lucas: And that's exactly why this one sold at 40x. The founder had been an IT consultant before starting the MSP, and he said the worst part of consulting was scope creep. So he designed the business to eliminate it. Luna: Let's talk about the numbers. What was the EBITDA margin? Because a high multiple on low margin is still a low valuation. Lucas: EBITDA margin was 38 percent, which is healthy for a services business. Revenue was about 2.8 million, so EBITDA was just over a million. At 40x, the purchase price was around 42 million. Luna: That's a massive outcome for a 12-person shop. The founder probably walked away with 30-plus million after taxes and broker fees. Lucas: He did. And he structured part of it as an earn-out tied to client retention over two years, but the base payment was cash at close. Luna: That's the dream exit. But it also required years of discipline — turning down business that didn't fit the model. Lucas: And that's the takeaway for any small business owner listening. The market rewards predictability more than it rewards growth for growth's sake. A slower-growing business with locked-in contracts and high retention can easily outsell a faster-growing business with churn. Luna: I want to zoom in on the price escalation clause. Five percent annual increase — that's above inflation. Were clients okay with that? Lucas: The founder said most clients didn't push back because the alternative was managing IT themselves, which would cost more. He framed it as a cost of business increase, not a profit grab. And because he delivered consistent service — average response time under 15 minutes — clients felt they got value. Luna: So the escalation was baked into the contract from day one. That's key. You can't add it later without risking churn. Lucas: Right. And it meant that by year three, a client paying $5,000 a month was up to about $5,500. That extra $500 a month per client added up across 80 clients — about $480,000 in additional annual revenue by year three. Luna: And that's pure margin growth, because the cost to serve that client didn't increase proportionally. Lucas: Exactly. The help desk costs are mostly fixed. So the escalator dropped straight to the bottom line. The buyer's model showed that by year five, EBITDA would be 50 percent higher just from contract escalations alone, assuming no new clients. Luna: That's a beautiful model. I can see why they paid 40x. Lucas: You know, this kind of work takes a long time to build — the discipline, the systems, the client trust. And we spend a lot of time on every episode trying to share these real-world case studies because we think they genuinely help people think differently about their own businesses. Luna: Yeah, and if these conversations have moved your work forward in some small way — might be worth considering tossing a couple of dollars a month our way. It genuinely keeps these going ad-free. Lucas: It's buy me a coffee dot com slash fexingo. And we mean it — even a few bucks a month makes a real difference for a small show like this. Luna: Alright, back to the deal. One thing I'm curious about — did the seller use a broker, or was this a direct sale? Lucas: He used a boutique investment bank that specializes in tech-enabled services. They ran a targeted auction with about 15 buyers, mostly regional MSP platforms and one private equity firm. The auction drove the multiple up — the initial offers were around 25x, but the final round got to 40x. Luna: So the competitive process mattered. If he'd sold to the first buyer, he might have left 15x on the table. Lucas: Exactly. And that's something we don't talk about enough — how the sale process itself affects the multiple. A well-run auction with the right buyer universe can add 5 to 10 turns of EBITDA to the valuation. Luna: What about the employees? Did they stay on? Lucas: All 12 were offered jobs with the buyer. The founder stayed for a six-month transition. The lead engineer actually got a retention bonus. So it was a clean integration. Luna: That's good. A lot of small service businesses fall apart post-sale because the founder was the glue. Lucas: Right. But in this case, the systems were documented, the playbook was written, and the client relationships were distributed across the team. The founder had basically made himself replaceable — which is exactly what buyers want. Luna: So the lesson is: build the business so it can run without you, lock clients into long-term contracts with escalators, and run a competitive sale process. Lucas: And don't be afraid to say no to clients who don't fit the model. That's the hardest part, but it's what separates a 40x exit from a 10x one. Luna: Do you have any sense of what the founder is doing now? Lucas: He actually started a new business — a consultancy helping other MSPs prepare for sale. He says he realized that most small IT firms have no idea how to structure their contracts or operations for maximum valuation. Luna: That's perfect. He's essentially packaging his playbook. And he'll probably sell that consultancy in five years for another big multiple. Lucas: Wouldn't surprise me. The guy clearly understands how to build for exit from day one. Luna: Alright, let's leave listeners with one concrete action. If you're a service business owner listening, what's the first thing you should do tomorrow? Lucas: Look at your client contracts. If more than half are month to month, start experimenting with a one-year or two-year term for new clients. Offer a small discount — maybe 5 percent — to get them to sign. Then track whether retention improves. You'll have the data to prove the model works within 12 months. Luna: Simple, testable, and it directly increases your business's value. That's a great place to start. Lucas: Exactly. And if you want to dig deeper into the numbers from this deal, we'll put a summary on the show page. For now, that's what we've got.