Mergers and Acquisitions: More Clues on MSP Valuations

Mergers and Acquisitions: More Clues on MSP Valuations

I've spent recent weeks speaking with more than a dozen MSPs (managed services provider) executives, each of whom was involved in a merger or acquisition between 2007 and 2010. All of the deals involved regional MSPs in North America. My key question to them: What type of valuations do MSPs generate? The answers varied a bit. But I came to a pretty simple conclusion. Here it is...

... generally speaking, most of the sources told me my early estimates were off base. About a year ago, I suggested to MSPmentor readers that MSPs could fetch roughly 1.5 to 2.0 times their recurring revenues. In theory, that means an MSP generating US$2 million in annual recurring revenues is worth roughly $3 million to $4 million.

Now, for the reality check: All of the sources with whom I spoke requested anonymity. The reason: Most don't want the value of their completed M&A deals revealed. And three of the 12 sources are still active on the M&A front right now, with at least one M&A deal expected to close before the end of 2010.

Over and over again, the sources told me that most IT services acquisitions are valued at less than 1.0 times revenues. And in many cases, the deals involve targeted earn-outs. Translation: The selling CEO sticks around for a year or two and helps the buyer to hit key revenue and profit targets. If the targets are hit, the seller earns the associated bonus.

Your Mileage May Vary

Of course, valuation models can vary from one deal to the next. One MSP CEO who has worked on a few deals raises the following question:
"Is the company your about to buy in growth mode or in maintenance mode?"
Predictably:
  • Maintenance mode = lower valuation that depends heavily on current-year revenue target
  • Growth mode = higher valuation that takes next year's revenue projections into consideration
Prove to a prospective buyer that you've had year-over-year growth for the past three years, and clearly document how you'll continue that growth in 2011, and you'll fetch the higher valuation, perhaps earning a 1.2 valuation on next year's revenues rather than a 1.0 valuation on this year's lower revenues, notes the CEO.

Consultants Lend A Hand

Of course, I'm no M&A expert. But there are M&A pundits in the market assisting MSPs with potential deals. Two examples, as I've noted before, include Cogent Growth Partners and Weaver & Associates (launched by MSPAlliance Founder Charles Weaver).

No doubt, M&A deals are happening. But it's also wise to keep the rate of consolidation in proper perspective. During a busy month, MSPmentor hears about three to five MSP-related mergers or acquisitions. That represents a maximum of about 60 deals per year -- at a time when there are roughly 80,000 solutions providers in North America.

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