I noticed there are a number of you out there asking about M&A valuation metrics, specifically wondering how to go about determining your company’s value. While I’ve written extensively on this topic it seems that it may be time for another summary on the issue to help MSPs try and determine a reasonably accurate methodology to valuing a MSP business. Let’s get started.
Don’t Get Caught in the Multiplier Trap
“What’s multiplier should I use?” is a fairly common question I receive, mostly from CEOs who are trying to get a shortcut to arriving at a number representing the worth of their company. Typically, the question will focus on either a multiplier of recurring revenue or EBITDA. The best way I can answer this question is by saying that you can’t have a proper or accurate valuation by using one and not using the other. In fact, going a bit further, I would say that there are probably a number of equally important multipliers and data points which are necessary to achieving an accurate and defensible valuation for a MSP.
Let’s start with the basics. EBITDA or earning multipliers have very little practical value in the SMB market. I say this because many small business owners run their companies, especially during their early years, flat out in an attempt to grow quickly without regard to either debt, margin, or earnings. This style of management may be foreign to public companies, but since most MSPS are not publicly held, an earnings ratio is not typically useful for determining real value of a MSP.
Second, earnings or net income can be deceptive, especially if you are a company without a high amount of MSP business. For example, there are VARs who can, through effective management practices, create a decent net income and yet have little to no recurring revenue. In the world of managed services, a MSP with little or no recurring managed services revenue would not be worth much.
How Are MSPs Valued?
So, we’ve established you can’t rely on just earnings, net income, and recurring revenue multipliers. Now, what are the real metrics being used today in MSP valuations?
Recurring revenue is king. This is often the first metric a buyer/investor will look at during due diligence. Recurring revenue is the prime source of value for most MSPs; the service contract being the external evidence of a hopefully strong managed services relationship with a customer. However, it is not enough to just have a line item in your P&L statement to justify this metric. There are different levels of recurring revenue, from services actually delivered to managed services resold. Each one will command a different valuation multiplier.
Professional services, or non-recurring services are the next highest valuation metric used for MSPs today. Professional services usually represents easy additional revenue, typically with good margins, but without the predictability of managed services.
Last, hardware revenue is the least valued revenue category for a MSP or cloud business. Despite whatever margins you make, no matter how important you think it is to your customers, this category just does not interest many buyers (this hasn’t been a high priority for MSP buyers for the last 15 years). The only way you can turn hardware or software sales into something more valuable is if you utilize some form of Hardware as a Service model to make this revenue more predictable. For example, if you repeatedly sell hundreds of laptops to a customer, consider bundling those laptops into a HaaS model and you’ll radically increase the value of that revenue, both the services and the hardware.
M&A Outlook for 2015
We’ve still got some time left in 2014 but many MSPs are now looking at 2015 and beyond for their exit strategies. Tax rates, technology trends, and many other factors will weigh into your decision regarding selling your MSP business. While we have seen several major M&A deals “unravel” this year (Staples and BestBuy both sold their MSP divisions) the upside has been both these MSP businesses have been sold to other “IT firms”.
The market is fairly solid at the moment, but as cloud computing becomes more entrenched in the marketplace, MSPs who own their infrastructure (or at least own the service delivery within the cloud, as compared to reselling another cloud offering) will be more likely to command a higher valuation.
There is another trend emerging related to older MSP business owners beginning to seek exit strategies. Unrelated to competitive pressures, lack of growth opportunities, or any other similar factor, there are many MSP business owners who are simply getting to an age where they want to retire and now seeking out M&A options for their MSP practice.
While there could be a large number of these types of deals coming onto the M&A market, I suspect that internal “employee” acquisitions could be a preferred method for transitioning older owners to a younger generation of MSP business entrepreneurs.
In summary, there is no single multiplier you can use to arrive at a MSP value. If you do, any decent negotiator will be able to take another multiplier and drive down your value. A solid and defensible valuation demands value from both your managed services revenues as well as the margin or earnings produced from those services.