Why All MSPs Need to Understand the M&A Landscape

Why must all MSPs understand the industry’s M&A landscape, even if they are not actively seeking a deal? Because even if you’re standing pat, your competitors aren’t. Plus, if someone suddenly makes you an offer, you’ll want to know whether it really is too good to refuse.

During a recent webinar with MSP veteran Gary Pica of TruMethods, now a Kaseya company, we dove into how things look today on the M&A front and where they’re heading tomorrow. The M&A topic is more crucial than ever because the market is really heating up due to a few key factors.

The target market for MSPs is small and midsize businesses, and SMBs are continuing to increase their technology spending–even during the current economic downturn and recovery. SMBs will continue spending a larger percentage of their revenue each year as they revolutionize their systems.

This M&A spending is attracting attention, which means more money flowing into the space. Private equity firms are taking over software companies and the MSP channel, following the money that indicates growing opportunity.

At the same time, running and growing an MSP has become much more complex as customers demand an increasingly broader set of solutions. Providing a holistic, customizable offering requires investments in tools, technology and training, along with hiring staff with the right skills in a tight labor market.

Last, but certainly not least, MSPs and their clients are under near-constant attack. The quantity and quality of cybersecurity threats are increasing and evolving, spurred by higher-quality bad actors backed by deep pockets and foreign governments. Because 70% of security is hygiene, process, compliance and governance, MSPs are faced with the choice of growing and maturing their operations themselves, merging or partnering with a third party to get their security stance up to par, or doing nothing and take their chances.

It’s Still Early Days

Despite what may feel like a flurry of M&A activity in the MSP industry, it is only the beginning. Billions of dollars are still waiting on the sidelines. Meanwhile, M&A is top of mind for many MSPs.

According to our 2021 MSP Benchmark Survey, 26% of MSPs are looking to make an acquisition in the next two to three years, while 8% are hoping to sell during that same time frame. Not only does that indicate a future surge in activity, but it also means some MSPs not currently contemplating an exit might start receiving some unsolicited inquiries in the not-to-distant future.

These events are changing the nature of competition in the MSP market, even for those that aren’t active in the M&A arena. Private equity rollups are forming massive players along with an increase in MSPs with more than $4 million in revenue. These larger entities have proper sales and marketing organizations (often utilizing Kaseya’s Powered Services) interacting with your customers, educating them and arming them with tougher questions for you. Throw in the increasing complexities and importance of cybersecurity, and it’s obvious that scale is now a major competitive advantage.

 Who’s Shopping and What Are They Offering?

There are a few main types of buyers in the MSP market. Private equity-backed rollups are targeting MSPs with at least $1 million in annual EBIDTA along with smaller tuck-in businesses for strategic purposes. Meanwhile, “super-regional” MSPs with more than $8 million in EBIDTA are looking to accelerate their growth by buying up smaller players in their market.

Then there are strategic buyers that aren’t currently in the MSP business but are looking to add those services to their portfolio. These are typically office technology and services business, such as photocopier companies and accounting firms that already have a footprint with lots of SMBs.

Of course, the million-dollar question is how much are these companies willing to pay to snap up MSPs that fit their target criteria. Unsurprisingly, the more an MSP makes, the more they’re worth, and private equity firms are willing to pay a premium for larger outfits since they can serve as a platform for additional acquisitions.

There really isn’t a universal formula to calculate these valuations, but in general it’s a multiple of true EBIDTA. Firms with less than $500,000 EBIDTA tend to receive offers three to five times that amount, and those in the $500,000 to $1 million range are getting valuations of five to seven times true EBIDTA. Larger MSPs in the $1 million to $3 million ballpark are seeing seven to 10 times EBIDTA offers, while those at the top-end receive valuations 10 to 15 times their EBIDTA.

It’s also important to realize that many of these offers aren’t just big piles of cash and a handshake. Many include a combination of cash, stock and/or notes, often requiring key staff to remain with the new company for a period of time. The increased barrier to entry for the MSP market due to the greater complexity of cybersecurity, cloud offerings and more means they want the expertise, not just the customer base and assets.

 Valuation Factors

While EBIDTA is an excellent way to estimate what your firm might be worth, there are other factors at play. Since buyers generally have a strategic focus and aren’t just executing a pure land grab, they place additional emphasis on how an acquisition fits into that strategy and with the rest of their portfolio.

The nature of the customer base is also a key element, be it their size or which verticals they’re in. Most buyers aren’t looking to swoop up a ton of really small customers; they want bigger customers in growing industries.

An MSP’s operational maturity is also a factor. Wary of risky investments, most buyers want companies with solid processes, cybersecurity chops and a full staff. An owner more involved in the sales and marketing than the operations side of the house is also more attractive, since they know owners may not stick around after the deal closes.

From a revenue perspective, the split between recurring and non-recurring revenue is a big deal. Targets will ideally have 70% or more revenue be recurring, and 70% to 80% of that should be services revenue versus product based. They’re also shooting for a positive trajectory indicating that MRR is on a steady growth curve.

 How to Prepare … and Stay Prepared

No matter your plans today, the future is uncertain. It’s therefore a good idea to assess your business on a regular basis to stay ready for whatever comes your way. By calculating and tracking some important KPIs, you can see how you’re measuring up, identify areas to improve on, and be able to quickly respond if an opportunity to buy or sell comes along.

Having command over these numbers helps your MSP be seen as mature enough to warrant a decent valuation. And you can improve upon all of them by getting more efficient by using tools and automation. This includes creating smooth and consistent workflows across products, which is why a seamless suite makes sense versus a patchwork, hodge-podge solution.

However, the best thing any MSP can do to improve their valuation is what they should be doing anyway–focus on growth and profitability.

This guest blog is part of a Channel Futures sponsorship.