Latest / The Buyer & Seller Podcast with Fexingo: Business Brokers, Exits, and Private Sales Explained / Why This IT Services Firm Sold at a Shockingly Low Multiple
Transcript
- Lucas: So we got a note from a broker who handled a sale earlier this year that kind of stuck with me. Managed IT services firm, about two and a half million in revenue, recurring contracts, decent margins. And it sold for just five times EBITDA. Luna: Five times? That feels low for recurring revenue. Usually we see those go for seven, eight, even ten. Lucas: Right, and that's exactly why I wanted to dig into it. Because on paper, this business looked like a textbook candidate for a solid multiple. The revenue was sticky, clients were on multi-year agreements, churn was under five percent. But the buyers still hammered the price down. Luna: So what was the killer? Was it customer concentration again? Lucas: No, actually. The top client was only about eight percent of revenue. The issue was deeper. The founder was still the primary salesperson. He'd built the business on his personal relationships. Every major contract renewal, every new logo, everything ran through him. Luna: So the buyer looked at that and thought, what am I actually buying? I'm buying a guy, not a company. Lucas: Exactly. And the buyers weren't shy about it. They ran a data room check and found that the founder had sourced roughly eighty percent of the revenue over the past three years. The sales team was essentially order-takers. They could renew, but they couldn't hunt. Luna: Ouch. So the recurring revenue was real, but the engine that created it was about to walk out the door. Lucas: That's the key-person discount in its purest form. And it's often bigger than people expect. In this case, the broker told me the initial ask was seven and a half times EBITDA. The buyer came in at four and a half. They landed at five. That's a drop of over thirty percent from the ask. Luna: That's a massive haircut. And I bet the founder was surprised, because he probably thought his relationships were an asset, not a liability. Lucas: Right. And that's the trap. Founders think their network and their Rolodex is value. But to a buyer, it's risk. Because relationships aren't transferable unless they're tied to the company, not the person. Luna: So what could he have done differently? I mean, besides cloning himself. Lucas: Well, the obvious one is to build a sales function that doesn't depend on him. That means hiring a real salesperson, giving them actual autonomy, and letting them own the client relationships. Not just sit in on calls and take notes. Luna: But is that realistic for a two and a half million dollar business? Good salespeople are expensive. Lucas: It's a fair point. And the broker said the founder had tried. He'd hired a couple of salespeople over the years, but they never stayed long because he couldn't give up control. He would still jump on every important call, and the clients would ask for him by name. Luna: So he created the dependency himself. And then it became a self-fulfilling prophecy. Lucas: Exactly. And this goes beyond sales. The same thing applies to delivery. In this firm, the founder was also the top engineer. He was the escalation point for every complex problem. The engineering team was good, but they deferred to him on anything hard. Luna: So the buyers were looking at a business where the founder was both the rainmaker and the final line of defense. That's a double hit. Lucas: Yeah, and the buyers build that into the price. They model two scenarios. One where the founder stays for a transition period, and one where he leaves after a year. In the second scenario, they assume a chunk of revenue walks out the door. And they price accordingly. Luna: So the multiple they pay is basically a reflection of how confident they are that the business survives without him. Lucas: Exactly. And that's why we see such a wide range of multiples in the lower middle market. It's not just about EBITDA or growth rate. It's about how much of that EBITDA is portable. Luna: Portable. That's a good way to put it. So what did the founder do after the sale? Did he stay? Lucas: He agreed to a two-year transition as part of the deal. And the buyers structured part of the consideration as an earnout tied to revenue retention. So he's got a real incentive to introduce his clients to the new team and make those relationships stick. Luna: So he's basically being paid to make himself redundant. That's got to be a strange feeling. Lucas: It is. But it's a common structure in deals like this. And honestly, it's probably the smartest move the buyer made. They got a discount on the multiple because of the key-person risk, and then they used an earnout to make sure the founder actually transfers the relationships. Luna: So the founder took a hit on the price, but he's got a chance to earn some of it back if he does his job well during transition. Lucas: Right. And that's the nuance a lot of owners miss. They hear 'earnout' and think it's a trap. But in this case, it was a way to bridge the gap between what the buyer thought the business was worth without him, and what the founder thought it was worth with him. Luna: That's a really good point. So if you're listening and you're thinking about selling in the next few years, what's the takeaway? Start building that independence now. Lucas: Absolutely. And it doesn't happen overnight. The broker said the founder could have added two or three turns to his multiple if he'd started this process three years earlier. That's real money. Luna: Two or three turns on a two and a half million EBITDA business. That's maybe a million dollars difference. That's not nothing. Lucas: It's huge. And it's the difference between a good exit and a great one. So if you're a founder listening and you see yourself in this story, the time to start is now. Not six months before you list. Luna: Yeah. I mean, we talk about key person risk a lot on this show, but this case really brings it home. It's not just about losing the founder. It's about the perception of that loss and how it hits the valuation. Lucas: And that perception is shaped by data. Buyers are looking at your CRM, they're looking at your org chart, they're looking at who owns the relationships. If the answer is 'the owner,' that's a discount. Luna: So what's a concrete step someone can take this week to start de-risking their business? Lucas: Pull your top ten clients and ask honestly: if I went on a month-long vacation, would they even notice? If the answer is yes, you've got work to do. Put a plan in place to introduce your second-in-command to those clients, let them handle an issue or two, and slowly step back. Luna: That's a simple exercise but it probably gives a lot of founders a wake-up call. Lucas: It does. And look, we've seen it pay off. We covered that dental lab at eighteen times EBITDA a few episodes back. That founder had deliberately built a sales team that didn't need him. That's partly why the multiple was so high. Luna: So the contrast is stark. Eighteen times versus five times. And it's not just the industry. It's the structure. Lucas: Exactly. And that's the lesson. Buyers pay for businesses that can run without a single person. And the earlier you start building that, the better your multiple will be. Luna: Before we wrap, I know a lot of people listen on their commute and these conversations have helped them think about their own business. If you've gotten something out of this, a handful of listeners chip in monthly through buy me a coffee dot com slash fexingo, and that's literally what keeps this show ad-free. Lucas: Yeah, it's a small but mighty group, and we're grateful. It means we never have to run ads or sell your data. It's just us, talking about what we find interesting. Luna: And on that note, back to this deal. One thing I found interesting is that the buyer was a private equity group that had a platform in the IT services space. They were buying this as an add-on, not a standalone. Lucas: Oh, that changes the calculus a bit. They weren't buying the founder's relationships. They were buying the client base and the recurring revenue. They could plug it into their existing sales and delivery infrastructure, so the key-person risk mattered less to them. Luna: But they still used it as a negotiating lever to get the price down. That's a classic move. Lucas: Absolutely. Strategic buyers will absolutely exploit perceived weaknesses. That's why it's so important to address these things before you go to market, not just to get a higher multiple, but to avoid getting lowballed in the first place. Luna: So the message really is: the best time to de-risk your business was three years ago. The second best time is today. Lucas: That's the whole episode right there. Start building a business that doesn't need you, and the buyers will start paying for it.