30 Jan What’s Driving MSP Valuations?
The managed service provider (MSP) business model has become the standard for delivering IT services. The migration to cloud computing has significantly increased the scope and scalability that MSPs can achieve. These economic considerations have led to a wave of consolidations in the MSP sector, driving valuations to historically high levels. But these conditions won’t last forever. If you are thinking of selling your MSP and taking advantage of the hot seller’s market, here are the top drivers that will affect your value:
- Earnings – Generally reported as EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). MSPs with EBITDA of $1 million or more are highly desirable to strategic and financial buyers. The profit margin is also important, so the greater the EBITDA as a percentage of revenue, the more valuable the company. Well-run MSPs are achieving EBITDA margins of 15% or more. Smaller MSPs with earnings of at least $500,000 are also desirable for smaller buyers and as potential add-ons for larger buyers. Thus a strategy for smaller MSPs to consider is to merge with other small MSPs in order to achieve critical mass and become more attractive to industry buyers.
- Recurring Revenue – The MSP business model promotes recurring revenue and customer longevity. That is why MSPs receive higher valuations than other IT services companies. This predictability reduces the risk earnings and makes the business more valuable. Successful MSPs generate over 50% of their revenue as recurring revenue, and the highest performers often achieve 80% or more. They also minimize customer churn, turning over less than 10% of their customers every year.
- Growth – Buyers calculate the value of your business based on cash flow (EBITDA). They will start with historical performance, then ask ‘How much is this cash flow going to grow in the future’? The larger the historical base and the higher the growth rate, the higher the price they will be willing to pay. Successful MSPs are growing their revenue organically by 10% or more each year. You may also want to consider add-on acquisitions of your own. If there is a smaller local competitor that you can acquire, it will boost your growth rate.
- Size and Scope – Larger companies generally achieve higher valuation multiples than smaller companies. They have proved that they can scale, add management depth, continue to gain new customers, and minimize customer churn. However, valuations don’t go up smoothly as a company grows; the valuation multiple curve looks like stair steps. In other words, as companies become larger and reach new revenue and profit milestones, their valuation multiples increase. In addition to growing revenue, if an MSP can also provide services across a larger geographic area, they will be more attractive targets and often have a higher valuation than a local MSP.
- Customer Base – This refers to what types of customers you have and how diverse the revenue distribution is. If your company is focused on certain industries, that may be very attractive to certain buyers that are targeting that industry. However, if one or a few customers account for a majority of your revenue, that may reduce your valuation or even kill a deal. That means no customer represents 15% or more of an MSP’s revenue and no five customers represent 50% or more. A diversified customer base decreases the risk to the company’s potential revenues and profits.
- Other Factors – Different considerations may be important to buyers, some of which are subjective, but may make your company more attractive and drive up its valuation.
- Market differentiation – Your company may stand out because of its unique processes, systems, packaging or intellectual property.
- Key people – The strength and retention of a company’s key people, including management, sales, and technical, may be critical to an investor or buyer.
- Mature operations – A company that works from a plan, keeps good financial records, and has robust processes and systems, makes it more attractive.
- Range of services – Almost all MSPs outsource the management and monitoring of their customers’ network infrastructure. Now the leading MSPs are branching out into newer areas such as cloud services, cyber security, machine learning, and SaaS implementation.
No one knows how long the MSP market will be so favorable for sellers. If your company is growing, with strong, consistent earnings and low customer churn, you probably have a very valuable asset. If you have a strong, well-run company it makes sense that your value will be higher. If you need to strengthen some areas of your operations to become a top performer, consider adopting a performance improvement program to help overcome those hurdles.
The Austin Dale Group has many years of experience running, growing, and conducting M&A transactions for MSP businesses. We would be happy to talk with you about ways to achieve the most value in your business.