Mergers & Acquisitions: The Truth About MSP Valuations
First, who was on the panel:
How much is your managed services business worth? I don’t have an exact answer but MSPmentor gathered some important clues during an MSP Merger and Acquisition panel at the N-able Partner Summit today in Scottsdale, Arizona. Here’s a recap from real MSPs involved in real M&A activity, plus six merger and acquisition tips for MSPs.
First, who was on the panel:
- Dale Walls, president of Corsica Technologies, which has acquired roughly five solutions providers in the past few years.
- Jim Lippie, president of Thrive Networks, which sold to Staples around 2006. Lippie thinks Thrive is the only small MSP (about 60 employees at the time) that has sold to a Fortune 100 company.
- Jeff Simpler, co-founder of Simpler-Webb, which recently merged with HEIT to target the financial services vertical.
- Michael Drake, CEO of Master IT, a managed services provider that’s contemplating potential acquisitions.
Now, here are six highlights gathered from the panel and the broader N-able Partner Summit.
1. Valuations:
During the mid-2000s, MSPs could be valued at a high of roughly six times recurring revenues. But more recently, some conference attendees mentioned, most of the valuations are much lower. A few sources indicate that typical valuations are 50 cents per dollar of recurring revenue (or a $500,000 sale price for an MSP with $1 million in recurring revenue). Time and materials (T&M) businesses are valued at a lower price of roughly 20 to 30 cents on the dollar, according to some attendees who spoke on background.
Meanwhile, at least one MSP involved in a recent company sale insists that it’s still possible to fetch 1.5 times recurring revenues for a managed services company sale.
Separately, some MSPs are focusing more on EBITDA (earnings before interest, taxes, depreciation and amortization). In that case, sale price multiples can range from 6 times EBITDA to more than 10 times EBITDA, depending on overall revenues. The higher the revenues, the higher the EBITDA multiple, noted Simpler.
2. Who to Sell To:
Instead of selling to a peer MSP, Lippie of Thrive Networks recommends selling to someone outside of the traditional MSP market. The reason: A buyer who’s hungry to enter the managed services market for strategic reasons will likely be willing to pay you a higher valuation.
3. The Sale Process:
Lippie says Thrive Networks worked with an investment banker to prepare a “book” for potential bidders to review. The book included financial information and business information about Thrive Networks. The investment banker sent the book of information to roughly 60 companies that were interested in Thrive’s business. Next, Thrive met with about 12 companies face to face, to answer their inquiries about the business. Then, four companies ultimately bid on Thrive’s business and Staples had the winning offer, Lippie says.
4. When to Walk Away:
Walls of Corsica Technologies says he has walked away from potential acquisition targets because the potential sellers had businesses that were beyond repair. If the business is going to sink don’t try to save it, Walls says.
5. Who to Target:
As a potential buyer, Drake of Master IT is looking for MSPs that have customers that are willing to pay Master IT-level rates. Moreover, Master IT wants to acquire talent — specifically, MSPs that employ managers who can become virtual CIOs to end-customers. In stark contrast, Walls of Corsica Technologies says he’s mostly focused on buying customer bases. In some cases, Corsica retains the talent of an acquired company. In other cases, acquisitions are simply about buying up customer relations, then converting customers to managed services.
6. Mergers of Equals:
They’re rare. But a prime example involves Simpler-Webb and HEIT merging to form a national MSP serving community banks, credit unions and the financial services vertical. More than 70 customers and partners recently attended a HEIT summit focused on the financial services vertical.
Your Valuation Will Vary
Some readers have beaten me up pretty good for trying to pinpoint MSP valuations; they complain that by blogging about lower valuations I’m creating a sell-fulfilling prophecy that drives down valuations.
My reaction: Your company is worth whatever a buyer is willing to pay for it. To drive up that worth, drive up your recurring revenues and your EBITDA. But please don’t blame me for potentially driving down valuations. No doubt, valuations vary from region to region, deal to deal; no two deals are alive.
As one MSP said to me here at the conference, “It’s the dirty little secret of the industry; MSP valuations are not as high as they used to be. But that’s true of all high-tech. That’s why we’re seeing so much M&A activity.”
I agree.
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Joe,
This is a great article. You mention “some MSPs are focusing more on EBITDA”. I am probably reading into it too much, but I think the problem with valuations right now is that only “some” and not “all” MSPs are focusing on EBITDA. It does not matter what your revenues are if you have no profit. Couple low profits with the debt that many MSP’s are facing due to the high costs to get into the business and you have a company that has a very little valuation.
My recommendation is if you have any intention on selling your business you need to hire someone to handle your accounting and advise you on your finances. I am not talking about just hiring a book keeper, you need to hire a CFO. There are many out there that will work on a consultative basis. Work with them to put together a 12-18 month plan to clean up your books and focus your company on building a strong EBIDTA. Once your CFO can look at your books and give you an evaluation (from a purely financial perspective, not strategic) that you are happy with then and only then should you look to sell your business.
Lane
Lane: Thanks for sharing some real-world experiences.
Readers: Lane Smith is CEO of Do IT Smarter, a Master MSP that was recently acquired by ClearPointe. Here are some of the details.
-jp
Joe,
What I’ve seen in the past 1-2 years. Whether it’s the VC world or investment bankers or M+A firms, one of the most looked at metric these days for valuing a tech company (any tech company) is COS (cost of sales) and cost of customer acquisition. It all became a very hot topic after Solarwinds (and some others) went public or were acquired, at extremely high valuations. Why? They have extremely low COS and cost of customer acquisition numbers. It doesn’t matter if it’s a $50m software company or a $10m MSP, this still applies.
Todd Hussey
Todd@MSPexcellence.com
Building on the Cost of Sales theme: Some MSPs are considering acquisitions because it’s cheaper to acquire reseller customers than it is to pursue customers from scratch. This was a big theme during late-night discussions at summit…
-jp
Interesting discussion around valuation and Mamp;A for MSPs. Because MSPs have recurring revenue models, the way that most financial buyers will look at them is based on their unit economics and what they generate. These are the unit economics questions:
– how much does it cost, fully loaded, to acquire a customer (take all annual sales and marketing costs and divide by annual customers acquired)
– what is the average revenue per customer?
– what is the average length of each customer (take the number of existing customers you lose each year and divide by the total you had at the beginning)
Depending on the length of time you keep customers and the cost to acquire them, you either have a unit economic model that works, or doesn’t. The stickier your product, the longer your customers stay with you, and the higher margin per customer.
Strategic buyers will look at these unit economics as well, but they’ll also have other considerations as well, including geography, blocking a competitor from buying you, etc., which will make their interest level less easy to predict than financial buyers.
Peter Lehrman
CEO @AxialMarket
Peter: Your first metric (cost of customer acquisition) caught my attention. Some MSPs have examined the numbers and they’re finding it’s cheaper to acquire VARs and services providers rather than acquiring new customers organically. Hence, all the recent MA activity…
-jp
Guys,
The aged old challenge is “how to cost-effectively sell to the SMB/E”. But it has been proven to be do-able even when selling a low/no cash up front (recurring revenue) solution like managed services. It’s a different sales model empasizing lead volume, quick and accurate qualification, lots of phone during the sales process, ltd f2f appts, non-stop opportunity pipeline management, high close ratios, properly trained, managed and compensated sales staff etc. But yes, it can be done.