Recent M&A Frenzy Highlights Trend of Private Equity Firms Targeting MSPs
MSP acquisitions are seriously taking off as private equity firms look to buy. We asked our partners why.
April 22, 2021
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“It is interesting and exciting for our industry, as there is a need for investment in the tool sets MSPs use for their day-to-day. However, I do think the consolidation of both vendors and MSPs proves to be worrisome for some smaller MSPs who are concerned they won’t be able to compete with the “big boys.”
“For us here at ProdigyTeks, we feel the consolidation gives us an advantage with our target market [being] small businesses between 10 and 12 users. Most businesses that size want a more intimate interaction and not be assigned a number to get support from their helpdesk. This is where we’ve gained success.
“As we move forward, we shall see if the consolidation of the market actually brought dollar signs to the mergers, or to those like us who picked up clients because of the dislike of M&A.”
“I think the uptick in M&A and PE activity has to do with the fact that business acquisitions in general have increased, and MSPs seem to make great targets for great financial returns. Technology companies are sexy, recurring revenue is very valuable, and the needs for our services continue to grow. We are great targets on paper, especially considering the pressure of PE groups to put their dry powder to work.
“The success all comes in the PE group’s understanding of how MSPs operate most successfully. We are a relationship-based industry in many ways. Consolidation and integration can easily disrupt client and employee relationships, leading to both cultural and financial challenges. Organic growth is stunted in many PE rollups, which adds to the financial pressure. It’s not a recipe for success. A PE group that understands that the money follows the people, relationships and reputation can find an island of success among a sea of struggles.”
“This flurry of M&A/PE activity is happening simply because everyone is tired of COVID-19 and they want it to be normal again, especially with a stabilizing economy and growing Wall Street numbers. Depending on one’s viewpoint, they could be called wishful thinkers or opportunists.
“The reality is that the economy is slowly growing again, and with vaccines now widely available, things look better that they have in over a year. Therefore, many of the money players are looking to get a jump on the markets so they are looking for companies to acquire. And since the pandemic hurt so many businesses, there are a lot of people willing to sell.”
“The pandemic isn’t over, but the pieces are falling into place and people have a renewed hope in the direction of the economy. Businesses have been in freefall for a year or more. Some companies have been weakened by their response to the pandemic (which makes them cheaper for IP or similar), while others have weathered it and even flourished.
“Sharks are back in the water with acquisitions and companies are looking to merge to either grow or gain access to new resources. PE firms are just following the money. Tech weathered the pandemic as a whole, while other industries crumbled. This has created the economic conditions to foster mergers and acquisitions until the economy changes or is forced to change.
“The value of these mergers and acquisitions will come down to whether they have a reproducible and scalable process. PE firms want to see something as close to turnkey as possible (whether they intend to follow that process or not). Prospective mergers want to see an easy way to integrate both sides. Either way you slice it, a successful merger or acquisition of an MSP relies on standardization of the tools and processes a company employs to allow scalability.
“A company where a new owner can step in and follow a runbook to continue functioning (i.e. process oriented) is going to be more profitable on paper (and usually in reality too) than one which is a chaotic mix of ad hoc processes.
“Groups like The 20 or similar which allow a standardized stack while outsourcing many of the more difficult aspects for a managed service business can increase the potential value of an MSP. The more volatile the element to be outsourced, the better for the valuation in the eyes of a PE firm. There is a cost for adapting a business, and the lower that cost, the more likely it is to make business sense for both parties.”
“We think it is a massive, positive outcome for the space and sector. This will ultimately lead to certain MSPs being valued at higher multiples as demand increases for the space.
“IP in tech, predominantly AI and RPA, will be the main differentiators here. MSPs with in-house-built intellectual property will be worth a lot more than standard managed service providers. Reliance on tool sets and SaaS platforms such as Connectwise, Datto and Kaseya will be at its highest ever with the forecast that MSPs will experience significant growth in the next three to five years with the adoption of cloud and an uptake in managed services by more organizations.
“Changing demographics in age groups over the next 10 years will see demand for high recognition, low-touch services by MSPs. This will become more important than ever as younger professionals enter sectors with significant management roles.”
“PE firms build portfolios of money from investors. Right now there is a lot of money (or dry powder) that they need to invest. When they create a fund, they have a timetable to invest those funds, and often you can ask them where they are in their investing schedule.
MSPs were a hidden gem for a while because they are recurring revenue and profit. The big questions asked of MSPs are “what is your EBITDA?” and “What percentage of your revenue is MRR?” There are a lot of MSPs out there and a lot of recurring, contracted revenue that they can buy and grow.
They chose MSPs because they are largely started by technical founders who grew the business. Being in peer groups with a lot of other MSP executives, it is clear that the majority of them are much better at delivering technical service than they are at running a business. Sales, marketing and accounting are typically all weak spots in an MSP. PE firms can invest in MSPs while bringing on their own strength of business (sales, marketing, cost containment, etc) and bring up their EBITDA.
Many MSPs are being acquired because these factors:
A) Have a majority of their wealth locked into the value of their MSP.
B) May be looking to transfer that value into cash, and a chance to earn more later.
C) Might enjoy going back to a different role where their strength is, or join something bigger than they could do on their own.
The PEs will typically get one anchor MSP with a revenue of $10 million-plus, and then do bolt-ons with the chance to grow the EBITDA and then sell the whole thing down the road for more because the multiple goes up as the value and EBiTDA climbs. MSP owners can typically benefit from this second part of the sale. It could be a win-win for both.
“In terms of the projected success of these investments, I think there is mixed success on this. I have met many people who have sold their MSPs and then wind up doing something in a related field because the cash out and PE-dictated terms did not end up bringing in as much money as they thought. In other cases, I have seen a platform company (PE acquired) work to buy smaller MSPs, which brings about integration and pricing challenges (caused by culture and business misalignment).
“I know of quite a few successes where there is business alignment and the process is very thoughtful (expand geography, complement offerings, exposure to new verticals). In those cases, the job of the MSP changes to realizing the synergy and growth, but the focus ends up being more about growth of EBITDA to meet the PE’s goals for a future liquidation event.
“There is a lot of FOMO for MSPs right now in terms of getting acquired. ‘The market is good right now, you should do it because when the market falls, so will your valuation.’ ‘The earlier you get in on a roll up the better your terms are as part of the whole package, so don’t miss out on this opportunity.’ I think MSPs have these messages constantly in their mind these days.
“To sum up, I think that this MSP M&A trend can be a good thing and make MSPs stronger if there are complementary skills and services that make the whole package better and stronger. And of course the most important is cultural alignment.”
“The MSP market is highly fragmented with as many as 20,000 MSP’s across the country. Many of these owners are nearing retirement age and are looking for an exit. Well-run MSPs generate a ton of free cash flow and a large percentage of their revenue is contractually recurring. These factors have generated a great deal of interest from the private equity community. As demand for these companies increases, so does the price that larger MSPs and PE-backed organizations are willing to pay for them. There are a finite number of MSPs that have been able to grow in excess of $10 million in revenue and greater than $2 million in EBITDA, which again increases their value.
“It’s still very early in the consolidation cycle. Early reports are that a few large MSPs are on the market and a few deals have happened. Without being under the tent on those transactions, it’s difficult to know the full story, but word on the street is a few have been very good deals for the investors. As for my own MSP, we fully intend to have a successful exit. We believe one of the keys is to be disciplined in our acquisition strategy, and not get caught up in the feeding frenzy.”
“The MSP space has been ripe for consolidation for years and no one has figured out the secret sauce. A few factors are impacting why this is happening right now:
There is a bunch of money that has been “sitting on the sidelines” waiting for an investment opportunity, and the MSP space is in technology and it is a recurring revenue model, both of which produce high valuations and returns for investors.
Just like when housing prices rise, homeowners think about selling, the MSP multiples have risen and MSP owners are paying attention.
“In 2017, The Purple Guys ($4 million in recurring revenue at the time) acquired a local competitor with approximately $1 million in recurring revenue. We retained the revenue and retained almost the full team, a win-win across the board. From 2018-2020, we continued to grow our recurring revenue to $7 million.
“Two months ago, I sold The Purple Guys to ECS+MyIT. We are in the initial stages of our integration. I fully expect this transaction to be as, if not more, successful than our transaction in 2017. I am so confident that I re-invested in the company, and I am remaining a part of the executive leadership team. Growing an MSP purely through organic growth is possible, but to maintain 20%+ growth at any scale is extremely hard without making investments.”
Private equity has taken notice!
With high margin and profitability becoming more prevalent in the MSP space, its hard not to see that there is opportunity for investment and profitability to be had. With so many changes happening and as-a-service becoming more commonplace, the days of transaction low margin sales are gone, and the new era of high margin, long-term engagements is on the rise. This makes for an investor’s dream! When normal investments’ rate of return is 5%-8% on average, it’s hard to not see the attractive 10-20+% margins available in the Mmanaged services space.
The icing on the cake makes it a very appetizing consideration. You are seeing more mature MSPs able to truly maximize on the customer value.
Some of the attractive aspects are:
Strong recurring revenue
Lengthy contract terms (36 months+)
High-value services
Longstanding customers
Customer/vertical diversification
Fragmentation in the market place, resulting in opportunity for growth through acquisition
The total addressable market is large.
“There have been several dozen PE investments in the managed services space. For most, it has helped propel those MSPs to new heights and also appears to have been of benefit. One noticeable effect is that it has made all other MSPs aware of acquisition, and the need to have your company in good financial/operational shape.
“As a whole, I think it has been good for the MSP community. It is very clear that managed services is becoming the place to go for small-to-medium-size businesses and the need is rising by the day. The good news for the MSP community is that well-run/profitable IT companies have a higher value and are being sought after. For those that are looking for an exit, there are now options that didn’t exist a few years ago.”
“There are always good opportunities out there for ambitious MSPs to grow through acquisition to support their organic growth. This is a great opportunity to either grow your existing revenue streams through acquiring additional expertise and clients, but also to add complementary areas of expertise to your business that you had not operated in before, and then look to cross-sell services to both client bases. With current interest rates low, there are good opportunities to grow, either through using cash reserves or low-cost borrowings. Also, due to the impact that the pandemic has had on certain MSPs, there may be some good value in the market for otherwise high-performing targets.
“From a private equity angle, due to all of the above, MSPs are attractive for investors seeking good solid returns based on MSP businesses with high recurring revenues.
“If an acquisition is well-planned and has a strategy behind it, then it should be successful. For an acquired business that is running well, then I think one of the keys to “evolution not revolution” post-acquisition is that the acquirer should take a “hands-off” approach. In that case, both parties need to take a step back and continue to run as they did, and not damage the reason that the business was acquired in the first place.
“If of course the acquired business was in a distressed state, then action is required to be taken immediately. Building scale through acquisition and cross-selling where appropriate should lead to success for all parties, and the acquired business can also benefit from absorbing additional skills and expertise from the acquirer as well.”
“There is a wide variety of reasons why people are looking to acquire. In my own experience, as many of my peers approach 20+ years in the business without hitting their intended goals, and with business models that too heavily weighted project labor, 2020 was a shock to many of them. Weak financials and a lack of recurring revenue have led them to be great prospects for acquisition.
“Others have developed deep expertise with tight integration with vendors or verticals, a quality that makes for great additions to organizations looking to add expertise, strengthen existing markets or break into new markets. The easy play is to acquire to get into a new geographic location and expand your reach.
“Lastly, others are looking to acquire to simply shorten the timeline for scaling. They can leap past the $2-$5 valley of death by purchasing other IT companies, and adding talent and clients that are more difficult to add organically.”
“PEs desire a recurring revenue model, which MSPs provide. The MSP marketplace is fragmented and there are not many of any size which provide an opportunity to do M&A rollups.
“PE firms have a lot of capital on the sidelines and want to get it invested, and managed services has a 10%+ CAGR (according to a number of marketplace analysts). All of this provides the dynamics which creates a hot M&A market.”
“There are very few industries out there where a company can make 20%-30% net profit, and PE firms are well aware of the opportunity in our space. They also know that our space will become more heavily regulated by the federal government in the next few years, which will create huge opportunities for the big guys, and the little guys won’t be able to sustain the demands.
“Success in terms of these investments has not yet been proven. The current round of rollups is too immature to see whether they will succeed, and at what profit margin. I believe they will be, but there are many different models for these rollups and none has had enough time to prove its efficacy.”
“I believe the rationale for PE firms investing is that MSP companies offer reliable long-term profit streams which increase in value with scale. Therefore, our sector is ripe for increased accretive value as it consolidates.
“I also think most MSPs are focused on the SMB sector, which is investing in technology more than any other section of the market currently.”
“The managed IT service business model provides the predictable cash flows that private equity firms look for in an investment. Last year we saw an uptick in resale activity within the TeamLogic IT network that was driven, in part, by private equity. We welcome the additional capital as private equity investment has proven to be a force multiplier for TeamLogic IT.”
“The reason I think this is happening has many different sides to it. With the recent focus on security, many IT guys or MSPs aren’t ready, nor have time to focus on securing their own systems. Many have grown up with computers and can make them work and fix them well.
“Second, this shift is causing many MSPs to work more closely with management, and while many are great at the technical side, some may be lacking on the business side or with communication with management.
“Third, this is causing many owners or executives to consider if this is a good time to exit and let someone else take over the reigns.
“And finally, many investment firms know that there is a lot of margin that can be had from reducing staff, software and resources. We have seen this same play with Kaseya and SolarWinds over the past few years.”
“The right PE partner makes a lot of sense because the MSP business is a profitable one. However, they are also cash-intensive, and so it allows owners to free up millions of dollars of asset values that they have tied up in their business without selling out their company. In our case, we were able to take some chips off the table and free up personal wealth and liquidity, all while remaining “in the game” and with all of the upside potential we see coming.
“It makes a lot of sense for PE firms because they have a lot of money on the sidelines. They need to snap up places to get a good return. The consistent MRR model creates a very reliable/consistent cash flow that provides a good return on that money. There are many factors involved, but overall I think this is positive for our industry. As with anything like this, there are good partners and bad partners and many have done a disservice to the industry and created a lot of problems and a bad reputation for both PE firms and for MSPs. However, the right equity partners can help a business owner accelerate their vision, and have more fun doing it.”
“We’re closing on another acquisition at the end of this month. There are a large number of companies that were already not innovating (started in the early 2000s or late 1990s) and with aging owners. Those folks were ripe for acquisitions before the pandemic, but the last 13 months have widened the gap between the successful and the slowly dying off.
“So far, we’ve been successful in purchasing somewhat distressed legacy competitors, reaching a break-even on the deals inside of eight months. It’s pretty great, because everybody is winning. We expand our base, and become more profitable, the previous owner gets a payday, the acquired customers get better service and the acquired employees are getting better pay and more benefits. Pretty cool.”
“We’re closing on another acquisition at the end of this month. There are a large number of companies that were already not innovating (started in the early 2000s or late 1990s) and with aging owners. Those folks were ripe for acquisitions before the pandemic, but the last 13 months have widened the gap between the successful and the slowly dying off.
“So far, we’ve been successful in purchasing somewhat distressed legacy competitors, reaching a break-even on the deals inside of eight months. It’s pretty great, because everybody is winning. We expand our base, and become more profitable, the previous owner gets a payday, the acquired customers get better service and the acquired employees are getting better pay and more benefits. Pretty cool.”
In case it somehow escaped your attention, there is an M&A frenzy afoot. Packs of private equity firms are gobbling up service providers.
Some speculate that this is thanks to the increase in demand for IT services due to the pandemic. Others say that the uptick has to do with the fact that business acquisitions in general have increased. Further, it appears that MSPs make great targets for great financial return.
The industry, it seems, has been fast forwarded about a decade. This is likely due to the increase of work from home, security, cloud services and different remote access technologies. According to Jorge Rojas, partner at Tektonic, the pandemic-induced uptick in IT services demand is a huge driver. This is definitely true, but we wanted to know what else is driving these buy-ups and consolidations, and why private equity firms are chomping at the bit.
We asked our partners to give us a little more insight as to why this is happening with seemingly more frequency and urgency. And, further, if these ventures will be successful. The overwhelming sentiment is, unsurprisingly and perhaps annoyingly, only time will tell.
Click through the slideshow above to see what our partners expressed regarding this development.
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