Managing partner, Cloud Equity Group. Private equity firm specializing in managed service provider investments.
Managed service providers (MSPs)—third-party IT firms that can service a wide variety of clients, from large corporations to individual clients—are in demand, especially given the increased need for remote connectivity during the pandemic. According to 2021 research by Gartner, the “cloud managed service market is forecast to reach $102 billion in 2025, growing at a five-year compound annual growth rate of 19.1% in U.S. dollars.”
Amidst this growth, some MSP owners might be looking to cash in, according to IT Glue’s 2021 Global MSP Benchmark Report. The company reported that based on 2021 responses from MSPs, it believes mergers and acquisitions interest “is returning to a pre-COVID level.” Specifically, the company found that approximately “32% of respondents are open to the idea, and 14% are ready to pursue M&A opportunities actively.” Additionally, 24% of MSPs were “looking to sell” or “open to the idea.”
As the chief investment officer of an investment management firm that invests capital in MSPs, I’ve been on the other side of the table. If you’re an MSP owner looking to sell all or part of your company, be it to another MSP, a private equity investor or another strategic acquirer, I encourage you to start the exit process early, ideally, at least a year in advance of your target selling date.
Additionally, if you think you might want to sell your business in the years ahead, start removing any waste from your profit and loss as soon as possible. Capital providers understand that adjustments to earnings before interest, taxes, depreciation and amortization (EBITDA) can be necessary, but these adjustments can complicate the sales process. Ultimately, your prospective capital providers will want clean financials. They often prefer double-digit EBITDA margins, not single-digit EBITDA margins that require a lot of adjustments.
Here are a few more tips that will help you maximize your valuation and increase your chances of having a successful merger or acquisition.
Get The Right Key Metrics In Order
Capital providers will want to see certain trends related to your business, making it vital that you put the right key metrics in front of them.
Sources of revenue and their trends are important drivers of forward-looking projections. Avoid overstating historical growth because of recent ad-hoc statements of work or hardware purchases, as they don’t represent the true trends of the business if they don’t have strong and consistent tailwinds behind them. Instead, detail what percentage of your income is true contracted recurring revenue. Capital providers will want to see that your MSP has a steady, regular income stream; ideally, that over 60% of your income is derived from true monthly recurring revenue, and that there was an increase in your monthly recurring revenue growth over the previous 24 to 36 month period.
There are also several customer-related stats you should provide. First, that you have a great customer retention rate—MSPs should strive for a 95% customer retention rate. Second, capital providers will want to see that you’ve been able to increase the average monthly recurring revenue per client. An MSP that can retain clients and grow those accounts by selling higher-priced subscription services (and more) is a better investment bet than one that can’t build upon its existing clients.
With that being said, capital providers will want to make sure that the bulk of your customer revenue is not from a single client. A good rule of thumb is that no single customer should account for more than 10% of your customer revenue. And as for new business, top-performing MSPs can onboard two to three new customers a quarter, and capital providers will be impressed if your company is on the same level or greater.
Outside of customer-related stats, outline the gross margin net of your labor costs. A baseline is for your gross margin net of labor costs to be over 35%; this will show capital providers that your MSP has valuable technical talent and isn’t relying on hardware sales alone.
Build A Strong Narrative About Your Team’s Strength
What differentiates a strong opportunity from “just an opportunity” in the eyes of capital providers? The people behind the MSP.
Capital providers want assurance that the MSP is in good shape for continued success. They want a strong, existing team that has a great track record and understands the history and inner workings of the MSP. If you want to exit your business entirely after selling, it’s even more critical that you have a good management team in place who can take over.
Help your capital providers get to know the faces behind the numbers. Create a narrative about your company’s people, and demonstrate how different team members bolster your business. Show capital providers that your company has excellent employee retention—it’s not a revolving door.
Metrics help create this narrative, too. For example, if you have a phenomenal sales team that keeps bringing in more and more revenue over the quarters, put those stats in front of prospective buyers. The more confidence prospective buyers have in your team, the better.
Diligently Evaluate Prospective Buyers
Offers should start popping up if you present and market your business well. And while valuation and term deals are important, I encourage MSP owners to thoroughly evaluate different prospective buyers and choose the one with the best fit.
A good starting point? Think through why you want to sell your MSP. For instance, if you’re looking to exponentially scale your current business, private equity might be the best route since these firms typically have the expertise and resources needed for scaling at that level. Learn how each private equity firm you meet with operates, specifically, their level of involvement. You might want, for example, a more hands-on approach, but the firm in question might be more hands-off.
No matter who your prospective buyers are, ask plenty of questions to get to know them and make sure everyone’s interests are aligned. By doing so, you’ll put your company in the best position possible for its next phase.
The information in this article is not legal or financial advice. You should consult with a licensed professional for advice concerning your specific situation.