MSP Mergers, Acquisitions, Valuations: Essential CEO and CFO Planning Tips
How much is your managed services provider (MSP) or technology solutions provider (TSP) business worth — and how can you structure a potential deal to buy or sell in the MSP and TSP market? ConnectWise CEO Arnie Bellini and Service Leadership CEO Paul Dippell tackled those questions during a Path to Success webcast today.
The webcast was the first in a multi-part series, which covers:
- Part One: Valuation and deal structure. I recap only a portion of the conversation below but the full webcast with deep metrics and extensive Q&A is available here.
- Part Two: Finding and closing a deal (Webcast is coming in April 2018)
- Part Three: Post-acquisition integration (coming in November 2018)
Even if you don’t plan to buy or sell a company, MSPs and TSPs should follow the shared tips from the webcast to ensure you run the company with maximum cash flow and quality, Dippell notes. Building on that point, Bellini noted that many MSP and TSP owners want to pass their companies on to kids or the next generation of management. To make sure you do that as beautifully and effectively as you can, MSPs should really zero in on the valuation and deal tips, Bellini added.
Bellini reinforced that point by describing how ConnectWise explored a potential IPO, which helped the company to really zero in on key variables that influence valuation. (ConnectWise does not, by the way, have plans to IPO at the current time.)
Overall, only about 30 percent of MSPs really understand the buying and/or selling process, according to Service Leadership figures. (I’m paraphrasing the figures and they certainly vary a bit from the 30 percent mark. But for the sake of brevity I’m publishing 30 percent.)
Valuations: The 50,000 Foot View
“The market is hot… crazy hot,” said Dippell. “Private equity groups are moving to consolidate this industry. And that’s a good thing.” Still, he conceded: There’s a catch: PE firms want to buy MSPs and TSPs that each have $5 million to $10 million in profit. Yes, that’s profit — not revenue, Bellini pointed out.
There are at least 8 to 10 variables for valuations. But Dippell boils it down to these multiples from January 2017 research, based on 2016 multiples and actual deals:
- Product valuation: Multiply each dollar of annual product resale by 0.122. So $1 million of product revenue equals $122,000 in valuation.
- Ad Hoc T&M Services: Multiply each dollar of annual revenue here by 0.493.
- Project Services: Multiply each dollar of annual revenue by 0.650. By the way, project services was worth a 1.3 multiple (far more than the 0.650 multiple) back in ’99, Dippell noted.
- Managed Services: Multiply each dollar of annual revenue here by 1.333.
- Private Cloud Services: Multiply each dollar of annual revenue here by 1.368.
By the way, Service Leadership expects to share new multiples for 2017 sometime in January 2018.
MSP Valuations Based on EBITDA
The valuation above is based on revenue. But valuations can also involve EBITDA dollars and EBITDA profit margins. Service Leadership says the typical profit multiples (assuming the seller CEO is paying him/herself a fair market wage) is:
- Companies that have EBITDA profit margins of 0 percent to 7.5 percent typically are valued at a multiple of 6.2 times annual EBITDA.
- Companies that have EBITDA profit margins of 7.5 percent to 15 percent typically are valued at a multiple of 7.02 times annual EBITDA.
- Companies that have EBITDA profit margins of 15 percent or above typically are valued at a multiple of 7.02 times annual EBITDA.
Of course, there are additional variables to manage on valuation — including business model, geographically, cash and debt, and more, Dippell noted.
This section of the webcast, in particular, is a must-attend. Dippell and Bellini shared plenty of banter about how to piece together a deal. I’ll share a few thoughts below but they don’t capture all the nuances from the webcast discussion. Among the key points:
- There’s an old saying in M&A: A deal will be successfully completed when both sides are equally unhappy. “We both win enough to make sure both sides of the table believe the deal is worthwhile,” as Dippell put it.
- Deal structures are all about risk-reward. For the buyer, that means perhaps paying less money up front to lower the risk — but offering a higher-value earn-out (often one-year post-sale) to reward the seller for long-term performance. For the seller, that may mean demanding more money up front — but taking less of an earn-out target in order to reduce the buyer’s risk. Here again, tune into the webcast because the details go much deeper.
- The duo also covered stock vs. asset purchases, including some great graphics. But as Dippell pointed out: Talk to tax attorney to advise on which approach to pursue, regardless of whether you’re a buyer or seller.
- Control the timeline — the person that’s in a rush to do a deal has less leverage than the person who wants to move along slowly on a deal.
Whether you buy, sell or hold — never overlook the number one thing that typically holds back an MSP from growing from $3 million or above: Hiring and training a solid management team — particularly a second layer of management below the C-suite. HTG CEO Arlin Sorensen made that very point during IT Nation in November, Dippell noted. Bellini, meanwhile, told partners to zero in on all types of recurring revenues — not just traditional managed services revenue — to drive valuations higher.