I’ve spent recent weeks speaking with more than a dozen MSPs (managed services provider) executives, each of whom was involved in a merger or acquisition between 2007 and 2010. All of the deals involved regional MSPs in North America. My key question to them: What type of valuations do MSPs generate? The answers varied a bit. But I came to a pretty simple conclusion. Here it is…
… generally speaking, most of the sources told me my early estimates were off base. About a year ago, I suggested to MSPmentor readers that MSPs could fetch roughly 1.5 to 2.0 times their recurring revenues. In theory, that means an MSP generating US$2 million in annual recurring revenues is worth roughly $3 million to $4 million.
Now, for the reality check: All of the sources with whom I spoke requested anonymity. The reason: Most don’t want the value of their completed M&A deals revealed. And three of the 12 sources are still active on the M&A front right now, with at least one M&A deal expected to close before the end of 2010.
Over and over again, the sources told me that most IT services acquisitions are valued at less than 1.0 times revenues. And in many cases, the deals involve targeted earn-outs. Translation: The selling CEO sticks around for a year or two and helps the buyer to hit key revenue and profit targets. If the targets are hit, the seller earns the associated bonus.
Your Mileage May Vary
Of course, valuation models can vary from one deal to the next. One MSP CEO who has worked on a few deals raises the following question:
“Is the company your about to buy in growth mode or in maintenance mode?”
Predictably:
- Maintenance mode = lower valuation that depends heavily on current-year revenue target
- Growth mode = higher valuation that takes next year’s revenue projections into consideration
Prove to a prospective buyer that you’ve had year-over-year growth for the past three years, and clearly document how you’ll continue that growth in 2011, and you’ll fetch the higher valuation, perhaps earning a 1.2 valuation on next year’s revenues rather than a 1.0 valuation on this year’s lower revenues, notes the CEO.
Consultants Lend A Hand
Of course, I’m no M&A expert. But there are M&A pundits in the market assisting MSPs with potential deals. Two examples, as I’ve noted before, include Cogent Growth Partners and Weaver & Associates (launched by MSPAlliance Founder Charles Weaver).
No doubt, M&A deals are happening. But it’s also wise to keep the rate of consolidation in proper perspective. During a busy month, MSPmentor hears about three to five MSP-related mergers or acquisitions. That represents a maximum of about 60 deals per year — at a time when there are roughly 80,000 solutions providers in North America.
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Posted In: Acquisitions | Finance | Mergers & Acquisions
Tags: Charles Weaver | Cogent Growth Partners | managed services acquisitions | Managed Services Mergers | Managed Services Valuations | MSP acquisitions | MSP Mergers | MSP Valuations | MSPAlliance
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Joe, having done a few acquisitions over the years, yes there are quite a few metrics that help determine the value. One that I keep going back to is, what you state as, “maint mode vs. growth mode”. The company (MSP in this case) that can show they have a proven history of being able to cost-effectively add customers/revenue gets a higher valuation (actually I believe much higher). eg a low COS, predictable sales engine in place.
best,
Todd
todd@mspexcellence.com
Hey, Joe. Being around the M&A block many times on both the sell and buy sides, I can see you or anyone on the sell side can get confused.
There are many variables important to a buyer and what they are depends on the type of buyer and what they are looking for. Financial formula methods of valuation use arbitrary variables like growth prediction but the methods are solid.
Multiplier methods often have a shelf life of a few months to a year before the numbers change while each buyer has their own theory on what that number should be. And to be honest, it’s a rare buyer that goes completely by top line revenues alone. All have different profit targets and are looking for the predictability you and Todd mentioned as well as other structure pieces including the role of the owner in his/her company and more. It depends on the reason they are looking at this possible transaction.
The best way to have an idea of the value of your business is to look in from a buyer’s eyes, have a valuation/evaluation done by someone else that knows the market and work on structuring the business for the valuation you want on that basis. What kind of buyer makes a difference here as well.
Ultimately, when in a selling position the buyer determines what your business is worth to them. The seller gets to decide if they want to do the deal or not.
George
gsierchio@consultantscoach.com
George: Your last two sentences should be required reading for all MSPs mulling an M&A strategy.
-jp
Interesting piece! Valuations do involve many investor factors, preferences and quirks. Mostly, I think low MSP valuations are due to linear vs hockey stick sales growth.
To increase market value and monetize new service opportunity from at least half their customer base, I believe MSPs must go beyond conventional infrastructure monitoring and offer end-to-end communications monitoring and management services. Infrastructure up-time and availability is only one small facet of IT operations. Every business’ life blood, not to mention its exposure and liability, is embodied in its electronic data management practices which include its confidential customer records and employee medical data. By providing customers with an easy-to-use IT communications monitoring process, MSPs can improve data management results with direct bottom-line benefits and set the table for an on-going feast of new MSP services for all to enjoy.
To support my premise, new technologies are available that address electronic data security and Web content management but which are mostly impractical for MSP service delivery due to high cost, integration complexities and lack of 3rd party support. These include DLP (data loss prevention), SIEM (security information and event management), SWG (secure Web gateway) and Log Aggregation systems. The value for such products is real and have earned high marks from analyst firms and buy recommendations from trade publication for their support of security and compliance process. These products have been embraced mostly by large enterprise customers but are unaffordable to the majority of SMB companies.
We started Congruity to bring enterprise IT best practices to the SMB market. Our solution incorporates key features found in DLP, SIEM, SWG and logging products, delivered as an affordable, easy-to-deploy software and services platform. Our unique technology approach leverages continuous 2-way packet communications and flow analysis. Network packets contain all the information anyone needs to answer any operational or diagnostic question: Is the network and data secure? Are operations compliant? Are network controls performing as expected? Where’s the source of an exploit?…and so on. Packets identify who accesses a network, what data is moving, where, when and how much. And they reveal the content of a communication such as social security or credit card #. Most technologies with these features are not designed for the day-to-day needs of IT administrators, executives, HR or 3rd party auditors. Because we designed and built our solution from the ground up, we deliver features that no other company can. There are products offering some capabilities, but none are priced, licensed or delivered with the simplicity, power and elegance for MSP delivery we built into our IT and business communications platform.
IT management is process-driven, not technology-driven. Providing access to relevant operational information gives one a measurable advantage. For those MSPs interesting in new service value (and revenue) for their clients, our IT communications and data management process just might be the valuation multiplier you’re looking for. Call me, I’m always interested in helping people create new capital.
Regards,
Scott Smith
President & Co-founder
Congruity Technologies
Boulder, co
Couldn’t agree more, Joe. Looking forward to our panel at SMB Nation in Vegas next month.
George
gsierchio@consultantscoach.com