Fund Partner Offers Glimpse Into Capital Investing in MSPs

For managed services providers anxiously searching for capital investment to fuel growth and overcome intensifying competition, it’s easy to forget that they’re often the ones in the catbird seat.

At least, that’s the case for the better-run MSPs, for which a quality balance sheet and clear market differentiation often translates into a long-line of suitors calling, courting and patiently waiting for a chance to invest thousands or millions of dollars, in hope the resulting growth will pay big returns down the line.

“There is more capital than there are (good) companies,” said David Stienes, a partner at Philadelphia, PA-based LLR Partners, which invests in growing technology companies, including managed services providers. “If you’re a quality company, you’re going to get a lot of incoming phone calls from guys like me.”

Last year, LLR Partners was among the groups that invested a combined $66 million in cybersecurity and managed services firm Digital Guardian.

In 2013, LLR placed a $50 million bet to help grow Virginia-based Cigital, which provides a broad range of cybersecurity offerings, including security-as-a-service.

Stienes’ firm is a late-stage capital growth investor, which means he and his partners seek out companies with a reasonably proven track record and a high likelihood they’ll be able to grow and succeed.

If all goes well, LLR Partners looks to cash out in about five years for double or triple its investment.

Investors come in all shapes and sizes, however, each with unique risk tolerances and expectations for return on investment, Stienes explained.

Angel investors or early stage venture capital firms, for example, seek to fund newer companies or even startups, in hopes of earning eight to 10 times their initial stakes for assuming much greater risk.

In the technology sector, the managed services provider business model has become particularly attractive to investors, Stienes said. MSPs tend to have relatively high margins and steadier income streams, boasting subscription models that offer good revenue visibility.

Among investment companies in the space, MSPs are second only to software-as-a-service firms, where the dearth of human resources needed to deliver service can push margins as high as 85 percent, Stienes said.

LLR Partners sees huge growth potential for IT companies involved in cybersecurity, healthcare and financial services.

Once the investors identify a firm in which they’re interested, initial contacts are made, marking the start of an often-lengthy courtship that sometimes takes years to consummate, if the deal ever closes at all.

In the case of LLR’s investments in Cigital and Digital Guardian, Stienes explained, “we started talking a year and a half to two years” before the deals closed.

Sometimes, the investors make an offer to a company whose owners just aren’t ready to pull the trigger, for any number of reasons. In such cases, the investing firm just sticks around.

“You talk every couple of months,” Stienes said, adding that the sides often use the time to grow a relationship and develop a rapport. “You’re just getting to know each other until there’s a point in time when the capital is needed.”

Larger or more sophisticated companies might engage an investment banker to raise the money. It’s not unusual for that banker to begin with a list of 100 or more interested investors, before whittling it down for serious discussions with a small number of the most appropriate suitors.

Once the sides agree to move forward, it typically takes about 30 days of negotiations to agree to terms, followed by a 60-day window for due diligence.

Depending on the deal, LLR Partners could be an active investor, offering advice and exercising influence through management decisions, Stienes said.

“Half the time we have control in the business,” he said. “Half the time we don’t.”

Similarly, the newly invested financial assets are typically split about evenly.

“Half the capital goes to facilitate growth,” Stienes said. “Half goes to the owners as a reward for prior performance.”

Stienes offered the following advice to MSPs seeking to put themselves in position to attract capital investment:

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