Acquirers are attracted to the recurring revenues and “sticky” customer relationships that MSPs and agents have built.

That insight comes from John Holland, managing director of Corporate Finance Associates, who urges partners to seek guidance if they want to sell their business. Both MSPs and agents are seeing a high level of outside investment and consolidation in their industries.

Holland will speak at the Channel Partners Conference & Expo, April 11-14, in Las Vegas. His conference session, “Maximizing Value in Channel M&A Transactions,” will take place on April 12.

CFA’s John Holland

Holland spoke to Channel Futures about M&A ahead of his talk at the event.

Channel Futures: What’s one thing most entrepreneurs don’t understand about how the M&A process works?

John Holland: Business owners are often flattered when acquirers initiate conversations and extend offers. Many acquirers have business development teams that initiate such conversations in order to capture “proprietary deals.” A proprietary deal is a transaction without any competing bidders. As with any asset such as a home, the optimal value of a business is garnered when multiple bidders compete for the asset. Therefore, business owners should resist the temptation to sell their businesses without a competitive bidding process.

Selling a business is a very, very difficult, time-consuming process. For most business owners, the sale of the business is the largest and most important financial transaction in their lives. Mistakes can be very costly. There is a risk of post-transactional litigation. Just as any business owner would go to a cardiologist for guidance on heart issues, it is important for business owners to reach out to experts like investment bankers, M&A attorneys and CPAs with M&A experience when the owners contemplate selling their businesses. Many acquirers have teams of financial analysts, accountants and attorneys. Therefore, M&A negotiations are asymmetric and to the acquirers’ advantage if the seller of the business lacks guidance from experts.

Since every business is unique, there is no universally agreed “rule of thumb” that applies to business valuations. The true value of any technology services business is determined in the tug-of-war of free market forces when the business (or an interest in the business) is sold in a confidential auction-like process. Investment bankers orchestrate a confidential, auction-like process that synchronizes the offers and pits the prospective acquirers against each other in order to help business owners maximize the value of their businesses and optimize the deal structures.

CF: What are some of the things the prospective purchaser is looking for in a deal?

JH: Acquirers seek upside potential while mitigating downside risk. Growing businesses attract many acquirers, while declining businesses often fail to find an acquirer. Acquirers are very attracted to businesses with recurring revenues and “sticky” long-term customer relationships, because such businesses are deemed to be low risk. That’s why managed service providers (MSPs) and agents are in such demand. Regardless of the type of business, the business owner can build value with recurring revenues and sticky customer relationships. Let me draw a parallel with another industry that everyone can understand. Acquirers are not at all interested in businesses that build new swimming pools or remodel old swimming pools on a project-by-project basis, but acquirers are very interested in businesses that bill monthly for servicing, cleaning and maintaining those swimming pools.

Acquirers are very interested in scale. Since the transactional cost of acquiring a company can be $500,000, with fees of attorneys and CPAs, it is not cost-effective for acquirers to acquire businesses with low earnings. Business owners with EBITDA (earnings before interest, taxes, and depreciation) of less than $1 million should consider merging with competitors to achieve that scale. As businesses reach higher levels of EBITDA, the pool of interested acquirers enlarges. Therefore, the valuations tend to grow in terms of multiples on EBITDA as earnings grow. In general, there is an “army” of acquirers interested in any tech services businesses with EBITDA greater than $3 million, especially if such businesses have some recurring revenues.

CF: What’s one way for agents to maximize their transaction value?

JH: Agents are very attractive to acquirers due to the recurring revenues and the sticky long-term customer relationships. Agents can maximize the eventual transaction value by achieving steady growth of revenue and earnings and by scaling the business organically or via merger with competitors.

CF: Is there anything else you’d like to add?

JH: When selling a business, deal structure is just as important as price. Deal structure means the methods and timing of payment in the acquisition. Every business owner dreams of an all-cash deal. Acquirers understand that after a business owner receives a lump sum of millions of dollars, the business owner is unlikely to be as “hungry” for the continued success of that business. So, the acquirers ensure that the business owner/seller continues to have “skin in the game” by including payouts over two or three years that are contingent upon certain revenue, gross profit or EBITDA targets (i.e. an “earn-out”). Also, some acquirers ask the business owner/seller to retain some equity in the business.