May 15, 2020
In Part 1, “What’s in a Name? Channel Partner Types and Positioning for M&As,” we discussed the key characteristics of companies in the IT channel partner space. Here, we explore mergers and acquisitions implications for channel partner firms and how these companies can prepare for an M&A.
Preparing for an exit, as with preparing for everything else in life, requires a goal as well as a plan. Is the goal to fetch a certain dollar amount when selling or to sell at a certain time?
Often, especially if valuation expectations aren’t realistic, both goals cannot be achieved concurrently, so you must make a choice.
Given the higher demand and valuations for managed service providers (MSPs) and cloud providers, should value added resellers (VARs) and systems integrators (SIs) endeavor to transform their companies to increase the purchase price when selling? Should MSPs try to grow faster by adding product resale to their offerings?
First, “transforming” means for a VAR or SI to fundamentally change its revenue mix to match the recurring revenue component typical of an MSP, with more than 60% of its total revenue being recurring. If a VAR or SI with $30 million in revenue adds $3 million of managed services, while impressive, it’s still a VAR or system integrator with only 10% or less recurring revenue.
Secondly, the probability of completing a successful transformation will depend on the time available until the planned sale and how well and firmly the transformation is managed.
If an M&A event is planned within the next six to 18 months, we don’t recommend any significant changes in company strategy because of the potential downside if the transformation isn’t successfully completed.
M&A Timeline Options
If the timeline until a merger or acquisition is longer, VARs and SIs have a couple of options:
Acquire a small MSP to help scale services and cross-sell – the challenge is integration, cultural fit, etc.
Focus on a vertical market [state, local and education (SLED) government agencies, health care, financial services]. We are seeing higher multiples for specialized players.
Use a managed services third party to help jump-start and scale your own capabilities.
Continue to be a VAR or SI, the best you can be, focusing on new technologies and higher-margin products. Make up in size what you lose in multiples when it comes to the valuation.
Implement a drastic change in the business model. We recently advised an MSP who started its business in the ’80s in the refurbished equipment space but successfully developed into a services company. The secret: It left the refurbished equipment business completely, focusing exclusively on services.
Organically transitioning the business.
Transitioning from a VAR to an MSP is a complex business transformation. When embarking on it, be aware of the risks vs. rewards. Will the long-term benefits outweigh the cost? The transformation will have to address and possibly alter the very characteristics that made the company successful in the first place: culture, founder’s strengths, customer base, employee mix and skill set, etc. How committed and dedicated is the owner to push this change through?
As to MSPs’ options to scale, we don’t see increasing the product resale component as a viable strategy to grow revenue and maximize the price when selling the company. The merger of equals is an alternative approach we have seen in recent months. That’s the combination of two and sometimes more MSPs, since a larger company is typically valued on a higher multiple basis. The success of this strategy will depend on how well one plans the merger and how well it executes the integration.
Ultimately the purchase price will be maximized by the fit between buyer and seller. Key questions we ask business owners when analyzing their company at the beginning of a sale process are: “How high is your opportunity funnel conversion rate? Why are you losing new business?” The answer will help identify the profile of buyers who would be able to eliminate or minimize that weakness. Buyers are looking for ways to improve a seller’s business and enable incremental growth, which is what the buyer is bringing to the table … other than money. It’s a factor that will justify a higher purchase price.
In summary, while part of the same ecosystem, IT services companies in the channel infrastructure space have a few intrinsic and distinct characteristics depending on their business model and history. Understanding those differences will help business owners and their management teams successfully plan and execute an M&A transaction.
Cristian Anastasiu has participated in more than 80 transactions involving sellers with revenue in the $5 million to $150 million range in areas such as IT services, software applications, managed services, IT staffing, cloud technologies, SaaS, IT security, networking, data center and other technology and engineering areas. His experience includes acquiring and integrating companies for Cisco, where he also was director of worldwide sales operations. Follow him on LinkedIn.
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