Panelists Offer Tips For MSPs Eyeing A Sale Of Their Business

Getting an MSP ready to be acquired can take a year or more of prepping the team, cleaning up the accounting and understanding the factors that affect its value, according to a panel of experts.

Whether looking to expand opportunities as part of a larger organization or looking to retire, the decision to sell an MSP business is the start of a long process. There is at least a year’s worth of preparation needed, both to get the company’s finances and team in order and to get the owner ready for what’s next.

That’s the message from a panel of MSP M&A experts and an MSP CEO at this week’s XChange 2024 conference in San Antonio, who told an audience of MSPs that they should be prepared for a long journey and a lot of hard work to not only prepare their company for sale but also prepare themselves for the changes they personally will face after the sale.

XChange was hosted by CRN parent The Channel Company.

On the panel, which was moderated by CRN Senior Associate Editor CJ Fairfield, were Briton Burge, principal at Rosewood Private Investments, a Dallas-based family-backed investment firm; John Holland, managing director at Corporate Finance Associates, a Laguna Hills, Calif.-based international investment banking firm; and Travis Mack, chairman and CEO of Valeo Networks, a Rockledge, Fla.-based platform MSP.

The panelists described the many tasks an MSP needs to do before selling itself, including how to find the right buyer, clean up the accounting, prepare the employees and even find the right kinds of lawyers.

They also discussed the post-sales experience, including the choices an owner has to make, such as will he or she remain with the new company.

The panel definitely hit the key issues around MSP M&A, particularly for MSPs who may consider being acquired, said Don Monistere, president and CEO of General Informatics, a Baton Rouge, La.-based MSP that itself has made several acquisitions with the help of its private equity buyer.

“I think the main message for an owner operator that started their own company, selling the company is going to be emotional for them,” Monistere said. “You have to take the emotion out of it and recognize that it’s a financial transaction, and you need to treat it that way. And if you’re an owner operator that’s planning to stay, it’s an interview process. The buyer is interviewing you, but you need to be interviewing them too because if you want to stay with that organization and grow with that organization, you have to feel good about it.”

Monistere also said having private equity people on his company’s board of directors is an important driver of success.

“I’ve always said I want my board engaged,” he said. “I want them challenging me. I want them challenging our executives. And the people who are going to do that the best are going to be the financial investors. So I welcome it. In fact, to me, a sign of danger in your board is when they’re not engaged, when they’re not challenging you, if they’re just letting you do whatever, and they’re not holding you accountable.”

There is a lot of work to do before selling an MSP. To better understand, here are important tips from people who’ve done such deals.

How do you improve the valuation of an IT business?

Valeo Networks’ Mack said there are multiple ways to improve valuation. Acquirers have a list of several factors, including location, recurring revenue and how a company fits the acquiring company’s strategy.

“We’re trying to stay in our requirement zone,” he said. “We want ‘singles’ and ‘doubles.’ We’re not trying to get home runs. These are just a handful of requirements that we have as we look at different organizations across the United States.”

There are several factors that determine valuation, Corporate Finance Associates’ Holland said.

“So often business owners don’t understand how businesses are valued and how private equity firms or large strategic buyers do that black magic to figure out how businesses work,” he said. “And so often business owners hear from someone at the golf club that, ‘Oh, I sold my business for a multiple of 15,’ and they believe that’s what their business is worth. And sometimes they plan their retirement accordingly.”

Holland said MSP organizations on average will sell for a multiple of five or six times earnings. And while some may be valued at seven or eight times earnings, others may sell at one or two times earnings, while some may never find a buyer.

What drives buyers to pay more for one business over another is a mix of factors, Holland said. Scale is important, as larger companies are generally seen as less risky. Having a deep, experienced management team so that the loss of a key executive has little impact is also important.

Also key is high-margin growth with a pipeline of upcoming deals, as well as reliable accounting, he said.

“And recurring revenue is music to the ears of the buyer because it represents stability of that company, especially if the revenues are contractual for a longer period of time,” he said.

Things that detract from the value of a business and scare off buyers is a focus on product sales over project sales; declining revenue, which could show a business is in trouble; a weak management team or high employee turnover; and a single customer accounting for a large part of revenue, Holland said.

“And then there’s litigation,” he said. “If you’ve got litigation, particularly with your customers, that’s a red flag that can be radioactive as far as buyers are concerned.”

How does AI impact the evaluation of a potential acquisition?

Rosewood Private Investments’ Burge said AI presents a massive opportunity in a couple of different forms for MSPs.

“From an external product perspective, I think AI could open up some really interesting new service lines, which could allow our customers to leverage AI to be more efficient,” he said. “Things as simple as FAQs, where their employees can ask HR-type questions or IT questions. And from an operational perspective, there will be a ton of ways to leverage AI to make MSPs more efficient in delivering their services. So if there was a company out there that was ahead of the game from an AI perspective, that would definitely positively impact the valuation.”

Mack called AI a game-changer for MSPs.

“Anyone that’s not trying to figure out how to leverage AI and not trying to figure out how to better utilize data from AI to support our customers is missing a wonderful opportunity,” he said. “We’re still in the first inning. Think about November 2022 when ChatGPT came online. Now it’s about how do we build the infrastructure to support our customers’ utilization of AI. I think right now it’s evolutionary. We are still trying to figure it out. If anyone comes to you and says, ‘Hey’ I got it figured out,’ they're absolutely lying. And I think you need to lean forward, figure it out, invest in your infrastructure, to really promote and drive AI within your infrastructure to better support your customer base.

How are MSP acquisitions usually structured?

Business owners often think when they sell a business that they will get 100 percent cash, safe and secure, but the buyers typically don’t want all-cash deals, Hollan said. Instead, he said, deals typically are a combination of cash and equity in the combined company.

“A certain percentage would be cash on close,” he said. “Let’s say 60 percent of the value in the business is cash on close, which is great. And then there might be some rollover equity where the business owner retains a stake in the company for the long term, say the next two years, in partnership with the buyer, which in this case would probably be a private equity firm. Another part of the structure could be what’s called an earnout, which is a contingent payout based upon the performance of the company over the next year, two years or three years.”

Absolutely everything in a deal is negotiable, Holland said.

“There are no fixed, hard rules about what the deal structure should be,” he said. “It’s in the seller’s best interest to try to maximize the cash flow, and it’s in the buyer’s interest to try to shift some of the risk to the seller. And the buyer can do that with an earnout. So if the seller of the business fails to achieve certain targets over the next year or two, then the seller doesn’t get that earnout, or might get a percentage of that earnout, which could be a painful loss for the seller.”

For Burge, his company’s goal in any transaction is to spread the risk appropriately.

“But it’s also about opportunity, and that’s what’s fantastic about rollover equity ... where the sellers are rewarded for their performance and performance of the company. And that ultimately benefits us in this case as the investors.”

Deal structure is about an MSP understanding what it wants, Mack said.

“You really need to figure out what your dos and your don’ts are, and what your goals are,” he said. “And once you understand what you’re willing to do and what you’re not willing to do, then you can go into a transaction with eyes wide open and structure the deal to fit you. And honestly, and this may be a cliché, most deals, you try to be win-win. The deals don’t work if one side feels like it didn’t get a fair value on what’s going on. And it’s really important that you pay attention to that, understand the different tiers of your structure, understand what you’re willing to do, and then try to be fair, to be above board, and to be straight down the middle with your negotiating technique.”

As an investment banker, Holland said that while he is a numbers person, in reality he is dealing with human beings undergoing a lot of stress.

“It’s exciting to sell the business, but it’s also terrifying,” he said. “And I always tell my clients, do some soul-searching. The hardest thing in selling the business is understanding what you really want in your heart. Do you want to stay in the business? Do you have fire in your belly? Do you want to partner with a private equity firm to keep growing the business? There are great private equity firms that would be wonderful partners, and then you get what we call a second bite of the apple with an investment that pays off over the long term. On the other hand, if you’re tired, if you’re just burned out, then probably it’s better to sell 100 percent of the company.”

After the sale, how do you separate emotion from the facts?

Given that selling the business that an owner has poured its heart and soul into is often the only such transaction they’ll make, it can be a really hard transition, Burge said. And the transition is different for each seller, he said.

“In some cases, it’s them running off into the sunset,” he said. “In some cases, maybe they were the leader or CEO, but now they’re not the top person in the firm. This all has different effects on people. It’s always something that you have to manage. I think finding the right deal structure, the right partner, has an impact on whether you’re staying or going.

If anyone says they don't have seller’s remorse, they're not quite being truthful, Mack said.

“You have to look deep inside of you and understand what you truly want to do,” he said. “I found a lot of sellers have to decide what they truly want to be in the next version of themselves. And really, that’s a hard conversation. You’re all Type As. I don’t care what you say, you’re all Type As. Everyone thinks their idea is the best mousetrap, and this is the way we’ve been doing it, and this is the way it should be done. This customer likes this. But everything evolves, everything changes, and you’ve really got to make sure internally that you’re going to be able to make that transition.”

If a seller can’t make that transition, that’s where seller’s remorse starts, Mack said.

“You have to understand that once you get acquired, you’re no longer the boss,” he said. “You’ve got to operate within the confines of the new organization, and you’ve got to operate with the strategic direction of the buyer. That is a challenge for the seller, and you’ve really got to understand that and know that internally, and you got to have heart-to-heart conversations with yourself.”

Once the acquisition is done, how difficult is the integration?

Integration is less of a science and more of a process of figuring out what does and doesn’t fit strategically and technically, where the company is looking to go, and what improvements can be made, Mack said.

“But you’ve got to be sensitive, and you’ve got to be empathetic to what’s going on with the other side as well as with yourself,” he said. “I think it’s challenging. Anyone that says it’s easy, cut and dry, I would disagree. You have to look at it from an empathetic perspective, an operational perspective and from a cultural perspective. And at the end, try to navigate those waters.”

These all impact how the seller’s team integrates with the buyer, Mack said.

“You want the team to stay together,” he said. “That’s the No. 1 goal. I want the team here. I want these individuals to support this customer base because they know the customer. No one knows who Valeo Networks is. Your customers don’t care about Valeo Networks. They don’t care how big we are. What they do care about is, this systems engineer, this technician they’ve grown to know over the past five to 10 years, someone they’ve had a trust relationship with, can they keep that relationship intact?”

Integration is like building a house: it will take longer and cost more than you thought, Burge said.

“Different organizations have different cultures, and unifying them under one banner can be challenging,” he said. “So I think it’s something leadership has to be focused on. I think our leadership has done a great job of really evangelizing its culture and taking the good from each of the companies we bought to build a really cohesive team.”

What happens after the deal closes?

Holland said there are two types of companies that acquire MSPs: strategic buyers, which are bigger companies buying smaller companies, and private equity firms or financial buyers.

“When a strategic buyer acquires a business, they typically absorb the smaller company into the bigger company,” he said. “The smaller company gets dissolved. The name disappears. I call it a ‘jersey change’ because employees put on the jersey of the bigger company. So that’s a done deal. And for a business owner who just wants to retire, that’s a pretty good path.”

Private equity firms operate differently, Holland said.

“If it’s a big enough company, it would be what is called a ‘platform [MSP], and the private equity firm will partner with the founder of that company to search for add-ons or bolt-on acquisitions,” he said. “Let’s say the private equity firm buys a platform MSP in California. They might then look for an MSP in Chicago, and one in New York, and one in Florida, trying to build a national MSP, and then look for specific services to complement such as cybersecurity or artificial intelligence. They’ll try to scale that business as quickly as possible with the intention to sell it within three to five years, or up to seven years.”

At that point, the platform MSP owner might do an IPO or sell to another private equity firm, Holland said.

How do economic pressures like inflation and interest rates impact MSP M&A?

In theory, as interest rates go up, the cost of capital is higher, and buyers should be willing to pay less for business, Holland said. Higher interest rates should cause valuations to go down, and that happens in many industries.

“But in this cycle, when the interest rates climbed in the last year and a half or so, we didn’t really observe valuations descending like I would have expected. I think it’s because there are so many private equity firms going after the hot sectors of IT, MSPs in particular with their recurring revenue. I think that as interest rates go down, we’ll see a bit more activity in the MSP space, but to my surprise there really hasn’t been much impact there.”

The critical infrastructure nature of IT and MSPs shielded valuations from higher interest rates, Mack said.

“Look, show me a business that can run without technology infrastructure, and I’ll show you a business that does not exist anymore,” he said. “Critical infrastructure is a vertical that is absolutely needed, and I think that’s why it was able to sustain the interest rates. … Investors, as they look at the opportunities in front of them, see IT services as really attractive, even at a time when interest rates are up and other uncertainties are out

there.”

When interest rates were at their low point during the pandemic, there was a surge of M&A activity, but it didn’t really translate as higher valuations, Holland said. And as interest rates rose, there were fewer transactions, but still more than what the industry saw before the pandemic, he said.

When the economy moves toward a possible recession, as may be happening now, it becomes a double-edged sword for someone considering selling their business, Holland said.

“Falling interest rates tend to energize capital markets,” he said. “So I would say this is a great time to sell an IT services business, no matter what kind it is. And I think it would be even a better time in the last quarter of this year, or next year, and so forth. But if the economy does slip into a recession, then you start to see revenue slips, earnings slips. That can affect valuation, so that’s something to keep in mind.”

What’s one piece of advice you would give to an MSP looking to sell its business?

You have to put together the right team, Burge said.

“One of the things we run into a lot is systems and processes that aren’t clean and can cause disruptions,” he said.

That is an important point, especially during the due diligence process, Holland said.

“The acquirer sends the seller a due diligence list that’s seven pages long asking for all sorts of information,” he said. “And throughout that due diligence process, there’s an expectation that the seller is going to provide quarterly or monthly financials and answer all sorts of questions. So you need to have your accounting systems in order. It’s really important that anyone who’s selling or buying a business gets professional advisers. You especially need an attorney. Not just any attorney, but an attorney with experience in mergers and acquisitions. It’s a particular field in law. I would say most general attorneys don’t know anything about M&A.”

Holland also recommends any business owner consult with a CPA or tax attorney to see if there are ways to reduce taxes on the transaction.

“There are ways, and perfectly legal ways, to reduce your taxes, and but you need to do that at least a year before selling a business,” he said. “And it’s a really, really important thing.”

Sellers should also give themselves enough time, at least a year, to get ready, Mack said.

“You have to prepare the books and prep the team,” he said. “The team is important. You need time to build the team. There are a lot of subject matter experts that get on stage to guide you through it.”

Photo, from left: CJ Fairfield, senior associate editor at CRN; Briton Burge, principal at Rosewood Private Investments; John Holland, managing director at Corporate Finance Associates; and Travis Mack, chairman and CEO of Valeo Networks.