Mergers and Acquisitions, MSP, VAR

Professional Services Company Valuations: The Earnout Math

ChannelE2E has spent considerable time tracking pinpointing VAR and MSP valuations (see our FAQ). But what if you consider your business to be more of a professional services organization? With that thought in mind, I chatted with a pal of mine in the accounting industry. Though not an IT services provider, he is an M&A expert -- and his company has acquired multiple accounting firms across the United States.

So how are professional services companies valued within the accounting sector? Naturally, metrics can vary. But he mentioned a few basic valuation metrics:

  • The typical professional services company valuation is roughly 0.9 to 1.1 times annual revenues.
  • Some sellers push for valuations as high as 2.0 times annual revenues -- but buyers typically walk away from the proposed deals. That high valuation "ask" usually arrives when a broker is involved -- but sellers are hard pressed to find and keep buyers at the negotiating table.

Waiting On those Payments

Now here's where things get interesting. In the professional services accounting market, the buyer often doesn't pay the seller upon closing. In many cases:

  • The seller joins the buyer and works for the buyer's accounting firm until age 65. Yes, this is a long-haul engagement rather than a quick exit.
  • Payments to the seller typically don't start until age 65 or so, and they stretch out over 1o years or so.
  • In essence, the company sale feels more like a 10-year pension payment to the seller.

So what does the actual math look like? Let's assume you run a $5 million accounting company. If you sell it for 1 times revenue, that's a $5 million exit. However, you won't receive payments of about $500,000 annually until age 65 -- continuing through age 75. And that assumes you were the only shareholder in the company you sold.

Admittedly, the valuation and payment metrics above vary greatly from the typical VAR or MSP exit -- where a portion of the payment typically arrives upon the deal's closing, and additional payments typically arrive over a 2- to 5-year earnout.

Still, for middle-aged business owners who lead VAR and MSP organizations, the 10-year professional services earnout model championed by some accounting firms could be of interest.

Joe Panettieri

Joe Panettieri is co-founder & editorial director of MSSP Alert and ChannelE2E, the two leading news & analysis sites for managed service providers in the cybersecurity market.