Funding: What Investors Want From Managed Services Providers

Founders Investment Banking LLC has considerable experience in the managed services market. The company is currently assisting ETG — a top MSP focused on the healthcare vertical — with several funding considerations. But what exactly is the state of the MSP investment market right now? And what do private equity firms — or large MSPs — look for before they pump money into smaller MSPs? Zane Tarence, a managing director at Founders Investment Banking, offers some clues.

“There’s a lot of money on the sidelines right now,” said Tarence, who has been with Founders for the last four years and has seen the MSP market pick up in 2011 after 2 1/2 years of turmoil. “A company like ETG, which focuses on the healthcare vertical, is perfect for us,” said Tarence — pointing to Founders Investment Banking’s healthcare advisory service.

What Founders Investment Banking Does

Founders’ key principals have a security license with a broker dealer. Founders does not invest in the MSP’s. Instead, people like Tarence match the MSP’s with private equity groups looking to invest and larger companies looking to buy. “We do what the stock market does for public companies, except we do it for private companies,” said Tarence.

Founders Investment Banking sees two potential types of investors in the MSP market.

1. Financial Buyers: In other words, private equity firms representing roughly $490 billion in total investment power.
2. Strategic Buyers: In other words, corporations that want to compete in the managed services market by acquiring some or all of an MSP. This pie represents over $2 trillion on the buyers sheet, with the majority of that money allocated for acquisitions.

The Process

When working with an MSP, Founders Investment Banking performs a full analysis of the MSP — called a Market Readiness Assessment (MRA). Based on the MRA, Founders recommends the most ideal financial path for the MSP — perhaps the pursuit of investment money or a complete exit strategy that involves selling the company. The MSP pays Founders what Tarence calls a “success fee” based on how much the MSP is sold for or how much money it receives in investment capital.

“Ultimately, it’s up to the company on what they want to do. And whatever they decide, we help them do that,” said Tarence, who was general manager for the private investment fund Digital Media Holdings and spent 12 years with IBM as a business development and IT consultant before joining Founders.

How Much Does A Broker/Investment Advisor Cost?

Based on MSPmentor discussions with a range of investment firms, the broker fee can involve an initial retainer fee — say, roughly $20,000 to $40,000 for three months of assistance. If the MSP-broker engagement attracts and investor or a buyer, the broker firm typically receives a 6 percent commission — minus the original retainer fee.

For a $2 million M&A or investment transaction, that would be:

• The MSP paying the broker $30,000 up front
• The MSP paying the broker $90,000 when a deal closes (or $2 million X 6 percent, minus the original $30,000 retainer).

Please note: MSPmentor offers the example above only as a general guide; broker engagements certainly vary from company to company.

What Do Buyers Want?

If an MSP decides to sell, Tarence said buyers are seeking four key qualities:

1. An Experienced Management Team with a Solid Track Record —  This must include a strong next generation of leadership to provide continuity.
2. A Leading and Defensible Market Position — including long-standing customer relationships, diverse client base, strong recurring revenue base and proven sales and marketing channels.
3. Attractive Margins — which are brought about by differentiated offerings and efficient infrastructure.
4. Growth Potential Through Multiple Strategic Avenues — i.e. platforms that can grow organically or through add-on initiatives.

Additional Options

Of course, Founders Investment Banking LLC isn’t the only company helping MSPs with investment and M&A guidance. Additional options include:

• Cogent Growth Partners, launched by several former MSP executives. Cogent is a buy-side M&A advisory firm that sticks around post-deal to assist with the integration process.
• Martin Wolf Securities, a middle market investment bank focused on the services industry. The company has assisted in more than 100 transactions since 1997.
• Weaver & Associates LLC, launched by MSPAlliance President Charles Weaver.

MSPmentor has tracked roughly two-dozen M&A deals so far in 2011. We’ll be watching to see if the parties above broker or advise on more deals in the months ahead.

Additional reporting by Joe Panettieri. Sign up for MSPmentor’s Weekly Enewsletter, Webcasts and Resource Center. Follow us via RSS, Facebook, Identi.ca and Twitter. Check out more MSP voices at www.MSPtweet.com. Read our editorial disclosure here.