It is no secret that M&A activity has increased steadily in the channel over the past few years. To dig into what drives MSP valuations and the steps owners should take to prepare themselves for an acquisition, we spoke with Evergreen’s M&A Advisor Craig Fulton.
Why the channel is poised for even more acquisition activity in the years ahead
Evergreen has pursued acquisitions in the MSP space aggressively over the past year, and Fulton says he has seen firsthand the significant growth in activity in the space.
“How we value businesses and think about them isn’t changing much, but the pace of activity is definitely increasing,” Fulton said.
The focus on M&A is also evident in the content and agendas of most, if not all, of the popular channel events many MSPs consider a staple of their business calendars. From peer groups to vendor conferences, everyone wants to get their version of the M&A story in front of partners.
“The channel has always talked about operations and business planning, and you used to see plenty of content at events about becoming more efficient and developing services practices,” Fulton said. “This is just the next version of that – more partners are focused on this stage of the business now.”
Building a sales function and solidifying your tech stack: what owners should do now
Not every MSP owner is actively planning for a merger or a sale within the next few years, but that doesn’t mean the best practices for a high valuation aren’t relevant to them. Fulton says planning now for whatever the future might hold is crucial for all MSPs at this point.
“I remember when I was studying business management being told that when you start something you should be thinking about your exit even while you’re just starting out,” said Fulton. “A lot of MSPs weren’t doing that, because there were frankly so many other things to worry about in getting started, but it’s important for everyone to ave an idea of what that will look like at some point.”
When partners think about getting ready for the market, they likely know to get their financials in order and consider metrics like profitability and EBITDA. To Fulton, though, that’s only one part of what makes an MSP an appealing target.
“Everyone’s looking at the percentage of your revenue that is occurring, and EBITDA is crucial, but those are the basics now,” said Fulton. “We’re also seeing more focus on what is in those service contracts, and whether those have an automatic renewal, and the length of those, and what the termination clauses are. I think of it like the housing market a lot: everyone has a house for sale, but do you also have a pool that bumps your valuation?”
“I also think everyone has to get focused on how their sales function works,” Fulton continued. “Building up a mature sales function that isn’t relying on the founder or CEO is crucial. Go to the peer groups and the conferences that teach how to sell and invest in that foundation now. Selling services is selling an outcome, and that’s harder than just selling a feature. It’s risky from an acquisitions perspective to buy an MSP that relies on its founder to sell with no other structure in place.”
Having a sales function that doesn’t rely on the personality or experience of the owner isn’t just important for valuations; it’s a sign of maturity any MSP should consider as the services market grows more competitive.
The same is true of tech stacks, particularly around security, as customers require more complex solutions and sesrvices to keep up with the pace of innovation.
What Fulton sees coming down the road for the industry
The M&A trend seems to show no signs of slowing any time soon. Fulton points out that many MSPs founded 15 to 20 years ago as the managed services world was developing in earnest are now at a point in time where many entrepreneurs begin to consider exiting.
Plus, Fulton expects to see some of the larger private equity-backed MSPs experience changes in funding structure or ownership as those funds reach the ends of their profit cycles. No one can predict the future, but Fulton says he’s confident there will be more major acquisitions over the coming years.
“This is just going to continue for the next few years as it is now, I think. The thing yet to be determined is what happens to some of those larger PE-backed firms, I think that’s the next thing we’ll watch play out.”
Every month, Jordan Smith breaks down the biggest deals in the channel. Revisit his June recap to see just how busy the M&A market is right now.