The fourth driver: where your growth comes from

You probably know three numbers about your business without looking them up. The share of revenue that is contracted and recurring. The share your largest client pays. And what would happen if you switched your phone off for two weeks.

A buyer's team will check all three, and it should. In my experience those are the numbers a buyer's team goes after first when it prices a managed service provider (MSP) in the $2M to $10M band. Then comes the question I would ask next: of your last ten new clients, where did each one come from?

The answer tells a buyer something your growth rate cannot. Two MSPs can add the same number of clients in a year and look nothing alike to a buyer, depending on whether those clients came through a channel the business runs or through the owner's own network. Where growth comes from is the fourth driver. When all of it arrives by referral, it reads as risk, because the demand depends on the owner and nobody can forecast it.

For ten years my job was pricing businesses from the buyer's side; today I am fractional Chief Revenue Officer (CRO) at a national MSP in the United States.

If you want the three drivers and the multiples first, read what moves an MSP's multiple.

A buyer's team re-cuts three things first

Diligence is the buyer's investigation between the handshake and the signature. The re-cut is the part where the buyer's team restates your numbers the way it actually believes them, before it commits to a price.

In this band, three things get re-cut before anything else I would look at. Recurring revenue, meaning how much of your income is contracted rather than project work and resale. Client concentration, meaning how much of it sits with your largest few clients. Owner dependence, meaning how much of the business stops when you stop. Size decides which band you trade in before any of them matter, and the drivers page covers each lever in depth, so I will leave them there.

Who sits across the table sets the ceiling. A private equity (PE) fund buying an MSP as its platform, the first company it builds a roll-up on, paid a median of 13.6 times earnings before interest, taxes, depreciation and amortization (EBITDA) in the comp set behind who buys MSPs. Add-ons, the companies bolted onto a platform the fund already owns, sit well below that. Buyer type and company size overlap in that set, so read it as a description, not a cause.

The reason it matters here: a platform buyer is paying for what the business becomes, and a business becomes something through clients it has not signed yet. Once the three drivers are re-cut, the next thing worth reading is where those future clients will come from.

The fourth driver is where the growth comes from

Growth rate is how fast revenue grew. Growth source is where the new clients came from: referrals and the owner's personal network, or a channel the business runs without the owner, such as search or a salesperson. The two are separate questions, and a buyer can get a comfortable answer to the first and an uncomfortable one to the second.

Take two hypothetical MSPs with $5M in revenue, each of which signed ten new clients last year. At the first, nine came through referrals, most of them from people who know the owner. At the second, six came through search and a salesperson the owner never had to brief. On a growth chart they are the same business. Across the table they read very differently.

Growth rate already has its place among the levers on the drivers page, and it is noisier than it looks. When I built my valuation quiz I left growth rate out on purpose: self-reported growth is noisy, and at this size it moves the multiple less than the three drivers do. Source is harder to dress up. A buyer can check it in your customer relationship management (CRM) system and in your calendar.

Why referral-only growth reads as risk

Referrals are the best leads an MSP gets. The trouble is what they cap. A referral-fed MSP grows at the rate its clients happen to talk to people who need help this year, and nobody inside the business controls that rate or can turn it up in a slow quarter.

A buyer underwrites a forecast, meaning the price rests on what the buyer believes the next few years will produce. Borrowed demand is hard to forecast. And where the referrals run through the owner's relationships, the fourth driver folds into the third: the pipeline becomes one more thing that stops when the owner does. That business is one retiring referral partner away from a bad year. It can be very well run and still be fragile, because the fragility sits in where the demand comes from.

Here is how I would expect it to play out, as an illustration rather than a documented request list. An analyst takes your last ten new clients and traces each one back to its first contact. If eight of them trace to you personally, the analyst writes a question in the margin: does this growth survive the owner leaving? Nothing in the documents you handed over answers it, so the answer gets priced.

The reverse reads just as clearly. If four or five of the ten trace to a channel with a name, a person other than you running it, and a history in the CRM, the analyst has something to forecast from. The question never makes it into the margin.

Where does an unanswered question land? In my read, the forecast gets trimmed, or part of the price moves into an earn-out, meaning it is paid later and only if the business hits targets after you sell.

My view is blunt. Referral-dependent revenue trades at a discount when you sell, and a predictable pipeline is a multiple story. I will not put a size on that discount. I have not seen data that measures it cleanly, and a precise number here would be invented.

The question shows up in large-fund diligence too. Bain & Company describes a large PE fund whose diligence on a software company set out to confirm that the company's commercial organization could sustain its growth rate into the future. Commercial organization means the people and process that win new business. Different industry, far bigger deal, same question: is the growth a machine or a network?

Referral-grown MSPs can still sell well

There is a fair counter, and an owner who has grown on referrals for twenty years should hear it. Referral-grown MSPs can still draw strong offers. I know of a large, profitable one that never ran another channel and still drew serious all-cash offers. Size, margin, contract quality and scarcity carry a lot of weight on their own. And the headline multiples passed around at events often include deal structure; the cash number underneath tends to be lower.

So I would not tell you that referral-only growth kills a deal. It adds a question, and the weaker the rest of the business, the more that question costs. A large, profitable MSP with clean contracts can carry a referral-only history. A $3M shop where the owner is also the whole pipeline has much less to carry it with, because there the fourth driver and owner dependence are the same problem counted twice.

What can change in twelve months

Growth source can start moving inside a year. An MSP I work with built a pipeline in under a year that does not depend on the owner's network: eight new clients each traceable in the CRM to a search click, with organic traffic from about 260 to about 10,000 estimated visitors a month in nine months.

Two limits keep that honest. It is one MSP, and eight clients is a start, not yet a track record. A buyer trusts a channel once it has produced for long enough to forecast, and Bain notes that commercial improvements often take one to two years to bear fruit, which is why, in its account, the most effective funds start on them during diligence. Nothing here promises a higher multiple in twelve months. What a year can give you is the beginning of a record.

The count tells you where you start. Zero or one non-referral client out of ten is referral-dependent, two or three is accidental, four to six is predictable, and seven or more is compounding; a sensible goal for one year is to move up one stage with a source record behind the move.

The usual exit advice, including the sequence for selling your MSP on this site, is to hand over new-business sales last, because it is the hardest part of the owner's job to transfer. That is right. It is also why the channel has to start early: the part you hand over last is the part that takes longest to prove.

What to do this month

1. Pull your last ten new clients and write next to each where the first contact came from. A client counts as non-referral only if nobody vouched for you first.
2. Mark each one that came through you personally. That number is where the fourth driver meets owner dependence.
3. Start recording the source of every new opportunity in your CRM from the first contact, so that a year from now the answer comes from a report instead of your memory.
4. Pick one channel the business can run without you and give it an owner who is not you. Run it until it pays for the next one.
5. Take the valuation quiz for a starting range. It prices the three drivers and leaves this one out, so put your count next to the number it gives you.

If you want to read your count and your number side by side with other MSP owners, that is what the private room and regular call in Know Your Number are for.