When I buy a business, one of the first things I look for is recurring revenue. Over time, I’ve learned that recurring revenue is one of the strongest indicators of stability, predictability, and long-term value. In fact, I now see it as one of the most powerful levers in small business acquisitions.
But not all recurring revenue is created equal. Some models are durable and sticky; others are fragile and misleading. In this article, I’ll share how I evaluate recurring revenue in small businesses, the mistakes I’ve made in deals where I misunderstood it, and the framework I use today to separate true recurring revenue from illusions of stability.
Why Recurring Revenue Matters
Recurring revenue is valuable because it reduces uncertainty. Instead of starting each month at zero, the business begins with a base of predictable cash flow. That predictability:
- Increases valuation multiples. Buyers (including me) pay more for businesses with recurring revenue.
- Stabilizes operations. Cash flow is steadier, reducing stress.
- Enables growth. Predictable income allows for more confident reinvestment.
- Strengthens resilience. Businesses with recurring revenue weather downturns better.
For me as a buyer, recurring revenue means less risk and more upside.
My First Lesson on “Fake” Recurring Revenue
In one of my earliest acquisitions, I thought the business had recurring revenue because customers bought from it regularly. But when I looked closer, I realized there were no contracts, no automatic billing, and no true commitment. Customers bought repeatedly because it was convenient, not because they had to.
When a competitor entered the market, those “recurring” customers disappeared almost overnight. The business didn’t have recurring revenue; it had repeat revenue based on habit. That experience taught me to dig deeper.
The Framework I Use to Evaluate Recurring Revenue
Today, I use a structured framework to evaluate recurring revenue in every deal.
1. Contractual vs. Non-Contractual
Is the revenue locked in through contracts, subscriptions, or memberships? Or is it simply repeat purchasing behavior? Contractual recurring revenue is far more durable.
2. Automatic vs. Manual Renewal
Does the revenue renew automatically (e.g., subscription billing), or does the customer have to take action each period? Automatic renewal dramatically increases stickiness.
3. Churn Rate
How many customers cancel each month or year? Even a small churn rate compounds over time. A business with 2% churn is very different from one with 10%.
4. Customer Concentration
Is recurring revenue spread across many customers, or concentrated in a few? I’m cautious if 70% of recurring revenue comes from three clients. Diversification matters.
5. Customer Value Per Period
What is the average revenue per customer per billing cycle? Understanding this helps me model lifetime value (LTV).
6. Lifetime Value (LTV) vs. Customer Acquisition Cost (CAC)
How much profit does each customer generate over their lifetime, and how much does it cost to acquire them? A healthy ratio (often 3:1 or higher) tells me the model is sustainable.
7. Upsell Potential
Does the model allow for expansion of revenue from existing customers? For example, can I add tiers, upgrades, or complementary services?
Types of Recurring Revenue I Value Most
Over time, I’ve seen recurring revenue take many forms. The ones I value most are:
- Subscriptions: Customers pay monthly or annually for access (e.g., software, memberships).
- Service contracts: Customers sign agreements for ongoing services (e.g., maintenance).
- Consumables with auto-delivery: Products customers need regularly, delivered automatically.
- Licensing fees: Customers pay for the right to use intellectual property.
These models create durability and transferability.
Types of Recurring Revenue I Approach With Caution
Some revenue streams look recurring but aren’t truly reliable:
- Repeat business without contracts. Customers return, but nothing compels them.
- Seasonal commitments. Customers may renew for one year but disappear the next.
- Discount-driven loyalty. Customers stay only as long as prices are lowest.
These models can collapse when competitors apply pressure.
Mistakes I’ve Made
I’ve overestimated recurring revenue before. In one deal, I assumed a “book of business” in a service company would transfer smoothly. But many customers were loyal only to the seller personally. Once the seller left, the contracts were canceled.
I’ve also underestimated churn. I thought 5% churn sounded manageable, but over a year, it meant losing half the customer base. That forced constant new sales just to stay even.
Both mistakes reinforced the need to evaluate recurring revenue carefully.
How Recurring Revenue Impacts Valuation
Businesses with strong recurring revenue often sell for higher multiples, sometimes double those of non-recurring models. That’s because buyers like me see lower risk and steadier returns.
But I only pay a premium if the recurring revenue is real, contracted, diversified, and sustainable. Otherwise, I discount the valuation to reflect risk.
How I Strengthen Recurring Revenue After Acquiring
When I buy a company with weak recurring revenue, I look for ways to strengthen it:
- Converting repeat buyers into subscribers.
- Adding contracts where relationships were previously informal.
- Introducing auto-renewal billing.
- Building loyalty programs or tiered memberships.
These changes transform fragile revenue into durable recurring cash flow.
Final Thoughts
Recurring revenue is one of the most powerful levers in small business acquisitions. But not all recurring revenue is created equal. I’ve learned to evaluate whether it’s contractual, automatic, diversified, and sustainable.
Strong recurring revenue models create stability, increase valuation, and reduce risk. Weak ones create false confidence.
That’s why I treat recurring revenue as a key diligence item in every deal I pursue.
I continue sharing my acquisition frameworks, lessons, and strategies at DrConnorRobertson.com, where I document the real playbook I use, deal by deal.