Why 50% of MSP, Cloud Mergers Fail (And How You Can Succeed)

Well, unless you’ve been living under a rock, you may have noticed there’s a lot of M&A activity going on out there. It’s not a new trend, but it’s certainly worth taking note of. Here’s why.

For the past several years, managed services providers (MSPs) and emerging cloud services providers (CSPs) have been buying up smaller competitors or merging with complementary companies. Large integrators, direct market resellers and retailers are buying managed services to augment their revenues and add cloud service capabilities.

The end goals for both are nothing short of increased revenue, incremental growth and added value.

The Painful M&A Truth

Yes, companies involved in M&As will often tout the synergies of the two companies, the great management and track records of the acquired company and the potential that will result from the closed deal.

The reality, though, is something much different that no one really talks about, but those doing the buying are well aware of:  More than half of all M&As fail. Why? Because they fail to increase the cumulative value of the combined company, which results in a greater debt burden and slower overall growth.

For M&As to succeed, the value of the acquired company must be recognized and amplified greater than the payoff terms of what it cost to buy the company. In other words, the combined company must exceed expectations. For that to happen, there must be more intrinsic and indisputable value in the acquired company before the time of purchase.

That may sound like a lot to ask, but there’s a benefit to the acquired company by building value – and that’s a greater valuation. The more intrinsic value the business can produce, the greater the acquiring company will pay for the assets. When you break it down, the  economics are simple and the formula for success is clear.

So what do you do?  There are two clean cut ways managed service providers can enhance their value center: what they’ve done (business operations) and what they do (competitive differentiator).

First: Focus On Operations

MSPs that decrease costs through automation and have low cost of operations (overhead) will look more attractive because there are fewer physical assets to pay for and maintain. Services delivered through hosted providers and automated resources also require smaller staffs, which also contribute to overhead containment. These are important factors for acquiring companies to understand, as they want to minimize their risk exposure to commitments while having a solid foundation for expanding revenue rapidly.

Of course, the best way to build valuation is through a large book of accounts – namely, sales. The more customers under management, the greater the value of the managed services business. The reason is simple: If you have 100 customers on long-term contracts (assuming no defaults), the acquiring business has a quantifiable and guaranteed revenue source. A solid book of accounts also provides an ample pool of customers for up- and cross-selling.

Second: Focus On Differentiators

It may sound trivial, but it’s not: MSPs that specialize in specific verticals (financial services or health care) and emerging technology (unified communications or identity management) tend to have a higher valuation. Why? Because they do things others can’t or don’t do. As a result, they have less competition and, depending on the total addressable market for their specialization, have greater potential for expanded and accelerating growth. The opposite concept: If you do what everyone else does, there’s little value in your business.

People keep talking about an IT services consolidation trend. The truth is solution provider M&A activity is continual – always has been, always will be. If your exit plan is to eventually sell, there will always be a buyer if you play your cards right.

Once you get your business in order, the next moves will focus on understanding what price your business will command on the open market and just how involved do you want to be after the sale.

Justin Crotty is senior VP and GM of NetEnrich, which provides closet to cloud services for MSPs. Monthly guest blogs such as this one are Talkin’ Cloud’s annual platinum sponsorship. Read all of NetEnrich‘s guest blogs here.