March 1, 2023
By Abe Garver
As a managed service provider (MSP) owner, you have put in years of hard work and dedication to build a successful business. If you’re vehemently opposed to ‘leaving money on the table’ and are contemplating selling equity for the first or second time (i.e., a “recapitalization”), this article is for you.
Having advised on MSP transactions with 55 parties over the past three years, our firm is frequently asked to share ‘Pro Tips’ to avoid leaving money on the table. Here are our top five, listed in order of the best place to start.
1. Be very selective about the MSP M&A advisory team that will represent you.
“We’ll remove your car for cash.”
Don’t laugh. It’s astounding to us how many MSPs have sold their life’s work to our industry’s largest private equity (PE) consolidator because it was the first offer they received.
If you can say “no” to their/any first offer, your likelihood of success (defined as a better financial, cultural, strategic and geographic fit) may increase exponentially.
In the same way, there are some questions you should be asking when selecting an advisory team. They include:
Can you show me 15 inbound emails you received over the past 30 days from PE buyers who are specifically searching for MSP add-on/ platform assets?
Can you connect me with 50+ MSP buyer/seller references you’ve transacted with over the past 36 months?
For which references have you built an MSP M&A pipeline as part of the sell-side process?
Can you show me how many MSP ‘merger of equals’ transactions your team has been the catalyst for/advised on and how much new value it created for your clients?
How many people on your team spend 100% of their time executing MSP transactions?
What valuation do you expect for our MSP in a sales process, and why?
Can you show me how much you will charge relative to the value you will provide?
And in case you need a tie breaker in making your selection, determine which MSP team leader has done the best job of marketing themselves and their team (number of MSP speaking engagements, articles written, webinars, times quoted this year, LinkedIn followers), These are the skills required to help you reach the largest and most qualified group of buyers and, most importantly, maximize transaction value.
2. Determine GAAP EBITDA.
Very few MSPs come to the market for the first time with financial statements prepared by GAAP. (Generally accepted accounting principles [GAAP] refer to a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board. U.S. public companies must follow GAAP when their accountants compile their financial statements.)
So for example, let’s say you enter a negotiation and agree to sell your MSP to someone for a specific price without knowing your GAAP numbers. In that case, both parties risk a major repricing event when the actual GAAP numbers are uncovered during the buyer’s quality of earnings (QoE) report. That report, which is typically produced about 30 days after the letter of intent is signed, helps investors understand the historical earnings and forward-looking performance of the business through rigorous financial analysis. QOE reports are one of the two most essential components of due diligence when buying a company, the other being legal diligence.
The repricing risk is so significant that buyers regularly refuse to …
… start their lawyers on the purchase and other critical agreements until they are confident that the amount of EBITDA you said you have, is confirmed within a range of plus or minus ~7.0% by the buyer’s QoE report.
Try and manage EBITDA (earnings before interest, taxes, depreciation and amortization) expectations to “land the plane” in the weeks leading up to close with a positive surprise to the monthly forecast (as opposed to a negative surprise) to minimize the possibility of a buyer re-trade.
3. Pursue opportunities to create “new value” during the sales process.
Be open to merging with an MSP in your peer group or one with complementary strengths to increase pro-forma EBITDA and valuation multiples. Given the scarcity of fully-integrated MSP platform assets of size ($2.5 million EBITDA, $5 million EBITDA and $15 million EBITDA are the most common requests we get), mergers of equals have become commonplace
4. Create an M&A pipeline for the buyer.
This will enable the buyer to buy their multiple down after acquiring your MSP. For example, a platform with $15.0 million of EBITDA seeking 15.0x EBTIDA comes to market with a pipeline of three $5.0 million EBITDA add-ons in signed letter of intent that it can acquire for 11.0x EBITDA. Because there is a path for the buyer to buy its multiple down to 13.0x after it has acquired the second $15.0 million in EBITDA for 11.0x EBITDA, it will be much easier for multiple buyers to rationalize paying 15.0x (or more) for the first $15.0 million of EBITDA.
5. Ask your MSP advisory team engagement leader to personally launch and make the market in your auction process.
Why not put your MSP’s best foot forward and leverage the personal relationships, brand, reputation and goodwill that your advisory team has established in the market?
Selling your MSP can be a complex process, but there are steps you can take to ensure that you get the best possible price and create new value during the sale process. By following the five pro tips above, you can maximize your chances of success, avoid leaving money on the table and ideally create new value during the sale process instead of having your car removed for cash.
Abe Garver is managing director and MSP team leader at FOCUS Investment Banking which has been ranked the #1 Lower Middle Market Investment Bank by Axial. Over the course of his career, he has worked on sell-side, buy-side and capital-raise assignments with approximately 150 clients. In addition to his work as an M&A investment banker, Garver is a magazine contributor, television commentator and conference speaker who has published over 125 articles in numerous publications. You can contact him by email at [email protected] or by calling 646-620-6317.
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