Posted March 31, 2011, by Larry Walsh, CEO and president of The 2112 Group
The channel has been hearing about the rolling wave of consolidation in the managed services market for more than a year. In the first quarter of 2011, there's been at least a dozen publicized and probably a few dozen more unpublicized mergers and acquisitions amongst MSPs. The demand for services capabilities is driving this activity as many see MSPs as the foundation for building channel-based cloud businesses.
Headlines about managed services acquisitions and consolidation are creating higher expectations for the value of these businesses. The MSP business-model promise is the creation of recurring revenue streams that ensuring predictable cash flow and profitability. Conventional wisdom says services are more margin resistant than hardware or software sales. And because managed services requires fewer people to support multiple clients, the cost of operations is lower. All of this adds up to a healthy, more valuable business.
Many of the managed services business sales are actually coming in lower than what owners expect. Rather than getting generous multiples on top-line revenue, they're getting valued based on their pre-tax profits or EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). The problem with placing a value on a managed service business is the lack of tangible assets beyond the customer accounts. Without a product, unique processes or real infrastructure, there's little to assess the value against besides people and accounts – both of which are transient.
A good example of low MSP valuation is ValCom Technology, an Illinois-based managed services company with nearly $40 million in annual sales. PC connection bought the company for $8 million with a $3.6 million earn-out if the management team meets its goals over the next 18 months. The companies report ValCom had an operating profit of 7.5 percent, which would place its net earnings at roughly $3 million. Assuming ValCom achieves its post-acquisition goals, the total acquisition will fetch 3.8 times operating profit.
The ValCom valuation may seem low to some managed services owners, but it's actually on the high side. Some merger experts and vendors tell Channelnomics that many MSPs are getting 1 to 1.5 times operating profit as their valuation.
Working against the sale of a managed service is oversupply. A dozen or more MSP acquisitions this quarter sounds impressive, but there are literally thousands of managed services companies of varying sizes dotting North America. Within any metropolitan area, you can find dozens of managed services companies that rarely run into one another in the field. An acquiring company has plenty of choice if all they're looking for is expansion.
Acquisition is the favorite exit strategy of many managed services business owners. They idea is to build a business to what they consider a reasonable level or to the point where they can no longer grow organically, then sell to the highest bidder so they can start their early retirement or move on to their next venture. But managed services acquisitions is hardly a "Field of Dreams" scenario in which you build it and they will come. Managed services need a plan ahead if acquisition is their ultimate exit.
Here are 7 tips for managed services looking to sell their companies. These tips aren't intended to be implemented at the beginning of an acquisition process, but long before acquisition is on the table.
- Know What You Want
Some MSPs see acquisition is their payday; the time when they can shed their responsibilities and collect the cash from years of investment in their business. Perhaps, but cashing out isn't the only thing MSPs should think about when selling. Are you looking to build the business or simply exit? Do you want to retain equity and treat the acquisition as an investment? Do you want to move on to new challenges? How do you want your people treated? Understanding what you want beyond just the sales price will help guide not just when you sell, but to whom and how.
- Define Your Business
Being a managed services specialist is not unique. There are thousands of MSPs that do the general flavors of IT management and support. MSPs that capture greater interest and higher valuations are the ones with unique capabilities and market positioning. mindSHIFT didn't buy Alpheon purely for its managed services, but for its specialization in health care managed services; Alpheon is quickly becoming the cornerstone of mindSHIFT's push into the health care market. Unique positioning equals unique value proposition, which differentiates your MSP from the hundreds of generic MSPs in the market.
- Sales and Accounts are Paramount
Many MSPs invest heavily in technical support and engineering capacity. This isn't necessarily a bad thing, but too often it's done at the expense of sales staffing. For small businesses, sales are often elusive in producing definable value back to the business, where engineering and technical staff have immediate impact on customers. The trouble is that MSPs need accounts to bolster revenue and valuation. If a business is acquiring an MSP, it's not for its technical infrastructure but rather its book of accounts. MSPs looking at an acquisition exit should place a priority on sales and building accounts if it wants a good valuation.
- Marketing and Promotion
Let people know who you are and what you do. Once you've established your unique capabilities, value proposition and sales capacity, let the world know who you are. This will help sales and account retention, as well as attract potential suitors. Acquiring companies don't want shrinking violets; they want companies with established reputations beyond their customer base. Strong market position is a reflection of business vitality and health.
- Market Diversification
Managed services gives MSPs the ability to support customers virtually everywhere. But that doesn't absolve an MSP of having presence in the local market. Once an MSP establishes a presence in a core market, they should expand into adjacent markets to increase their potential sales. Geographic diversification also guards against economic fluctuations, meaning the MSP can rely on New York and Pittsburgh to support operations even if the Boston and Philadelphia markets turn sour. Acquiring companies will look to MSPs with distributed reach over those confined to a single local market.
- Strong Team and Leadership Capabilities
MSP owners put a lot into their businesses. They invest their technical know-how, time and money into building their franchise. And to conserve resources and control expenses, they often take on most of the responsibility. But when it comes time to sell, the deal can't be predicated entirely on the owner-operator. MSPs need a strong leadership team that can run the various aspects of sales and operations. To a suitor, a strong leadership team demonstrates the vitality of the business. More importantly, it also means the owner doesn't necessarily need be retained by the new company.
- Always Take the Meeting
MSPs often get calls from potential suitors sniffing for a good deal. It doesn't matter what stage of development an MSP is at, it should always take the call from would-be buyers. Why? Market intelligence. Due diligence is expensive and can be a distraction, but simple inquiries needn't get to that stage. A few well-placed questions and one or two good conversations can give MSPs a sense of the prevailing market prices as well as what their company may be worth.
These are simple tips for managed services looking to be acquired. If and when acquisition talks get to the point of talking money and passing papers, MSPs should consult with an experienced M&A attorney and accountant to ensure the proper due diligence is done and their interests are protected. The point here is that acquisition strategies don't start when a suitor knocks on the door; smart MSPs plan for acquisitions long before it ever gets to that point.
Lawrence M. Walsh is CEO and president of The 2112 Group, a technology business advisory service that specializes in optimizing indirect channels and partner relationships. He's also the executive director of the Channel Vanguard Council. He is the former publisher of Channel Insider and editor of VARBusiness Magazine. You can reach him at firstname.lastname@example.org