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MSP business owners need to plan ahead, whether you want to sell your business in one year or ten. For most owners, the vast majority of your net worth is likely tied up in your business. Unlocking that value is essential in achieving your legacy and lifestyle goals during retirement or in the next chapter of life.
Creating business and shareholder value is not just a function of your business assets and services offered, it requires planning and consistent business execution over time. The numbers matter. With the flood of private equity interest in the managed services space, now more than ever selling your MSP is a numbers game, where the core financials drive shareholder value. Everything else is simply icing on the cake.
In this blog, we will explore the four most important business attributes to an MSP buyer.
1. Adjusted EBITDA
EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. In other words, EBITDA means operating cash flow. In a service-based business, capital investment and depreciation are often negligible. Therefore, EBITDA is the simplest and best metric to measure bottom-line business profitability.
Make no mistake: the MSP buyer is looking to purchase an asset that throws off a consistent stream of cash flow. The buyer is looking for above-average or best-in-class EBITDA margins that are consistent or increasing over time.
The concept of “adjusted” EBITDA has risen in importance lately. Savvy buyers realize that most MSP business owners pay themselves slightly below the market rate for their executive leadership duties. For closely-held firms, salaries can be kept artificially low throughout the year, allowing the business owner to later take profit distributions at their discretion.
Therefore, in nearly every case, the EBITDA or profit picture is inflated. When an owner sells their business, the new buyer will invariably have to recruit new executive talent to lead the business at the full market rate, immediately impacting bottom-line profitability. Therefore, MSP buyers will commonly adjust the EBITDA figure by an amount equal to the delta between the current owner salary and the going market rate for C-level talent in the local market.
2. Recurring Revenue
Recurring revenue is another key attribute sought by MSP buyers. The reason is obvious: recurring revenue is predictable, consistent, and has a lower cost of sale over time. What’s more, the “everything-as-a-service” trend has taken the world by storm. Now, most buyers want and expect to pay for things over time, usually in monthly increments, whether it be software or traditional business services, like tech support, legal services, bookkeeping, or accounting.
For MSPs, this means they should transform nearly every client engagement and service offering into a monthly recurring pricing model, if possible. Block time agreements and hourly-based project agreements are ultimately less attractive to MSP buyers. On the other hand, fixed-fee, monthly agreements are the name of the game.
Recurring service revenue is also attractive since it is more scalable and often more profitable over time. With managed services, MSPs can methodically increase the recurring profit margins by driving technology standardization with clients, thereby eliminating customization and complexity. With standards and simplicity, more service tasks can be automated or managed with fewer staff, leading to higher service gross margins. With project-based services, these sorts of labor efficiencies are elusive.
While services are the core of the MSP business model, product resale is still essential. Clients gain tremendous value from procurement, configuration, deployment, and ongoing management all being handled by a single service provider. Even here, clients and MSPs both benefit from recurring revenue models, especially for SaaS and cloud solutions. And lastly, for hardware, most clients are also looking for smooth and predictable monthly costs through leasing and other financing solutions.
3. Revenue Growth
Revenue growth is obviously very important to buyers. And yet, not all revenue growth is created equal. Simply put, a business that can organically grow topline revenues at 15-20% consistently will be vastly more valuable than a business that ekes out 5-10% revenue growth. With inflation currently raging, delivering 5% revenue growth in a service business is hardly even keeping up with the pace of inflation.
The quality of revenue growth can be measured in other ways as well. At times, revenue growth may become concentrated in a small number of key accounts. This can be dangerous and will not escape the buyer’s attention during due diligence. Whale hunting often moves the needle on revenue growth, but larger clients may trigger extra customization or special service requirements that degrade service profitability over time. Therefore, it is often wiser to build a solid base of evenly sized clients which permits higher levels of standardization, automation, and improved service gross margins.
Lastly, revenue growth can either be organic or inorganic from mergers and acquisitions. Organic growth is the “slow and steady” path to growth. While M&A can turbo-charge growth, it is high risk. Too often, MSPs suffer large-scale client defections from an acquired MSP. The reasons are many, but service quality changes and the end of the special personal relationships between the former business owner and their clients are among the top challenges to overcome after an acquisition.
4. Operational Maturity
Though hardest to measure, MSP buyers also attempt to measure the operational maturity of their acquisition targets. The concept of Operational Maturity Levels (OML) was popularized by Service Leadership, Inc. and their lead analyst and founder, Paul Dippell.
OML measures the maturity of the business processes, strategies, and services in a particular MSP. Higher OML firms will have strict technical standards that are enforced at the client level, tight financial controls, budgeting, and compensation schemes geared towards metrics and budget attainment. On the other hand, low OML firms will have few technical standards, higher degrees of client customization, lower labor efficiencies, and inconsistent service quality.
Measuring OML can be a tricky business. However, savvy MSP buyers have adapted the benchmarking techniques from firms like Service Leadership to size up acquisition targets in a systematic sort of way.
Dropsuite helps MSPs deliver standardized backup services that can easily be deployed to every client. Dropsuite empowers MSPs to drive recurring revenue while implementing technology standards and scalable service deployment for higher profit margins. At Dropsuite, we are proud to help our partners build thriving and highly profitable managed services businesses.