Written by: Charles Weaver, CEO of MSPAlliance

Hard cases make for bad law. That’s what US Supreme Court Justice Oliver Wendell Holmes once said. While it may have been true of the law, this concept could certainly apply to managed services. I’ll explain.

It has been long-established doctrine within the managed services community to have long term contracts. Longer-term contracts are more reliable, more predictable of the client’s sincerity, and more valuable to the MSP. But, as we face unique and difficult times due to pandemic, many MSPs are re-evaluating their approach to contracts and may be more open to monthly managed services agreements. I might agree with this thinking, in certain circumstances.

MSP Valuation and Long-Term Agreements

Having a considerable amount of experience in the M&A field, I feel confident in the statement that most buyers of MSP businesses would prefer longer-term agreements for managed services clients. I have seen many buyers attempt to lessen an MSP’s valuation because they had shorter-term customer agreements (more on this later).

This valuation concept has always driven MSPs to seek out long term agreements with their clients. While I do not disagree with the idea that a long-term contract does represent some stickiness with a client, I do believe that other markers are equally useful in determining MSP valuation that could conflict with the long-term agreement model.

Client Duration, Not Contract Length

Here is the argument for long-term agreements: if the agreement is the representation of a good relationship with a client, the longer the contract, the better the relationship. It seems like solid logic, but there are a few problems with this theory.

Scenario A: If a client signs a five year managed services deal and then the MSP sells to a buyer the very next month, what is the value of that revenue? You can see a more immediate problem with this valuation model. Any buyer would naturally be suspicious about paying a premium for that contract.

Scenario B: MSP signs a client to a monthly managed services agreement then sells to a buyer the next month. Would this be worse, in your opinion, than Scenario A?

Let’s take both of these scenarios and apply a new fact to them. Let’s assume, in both situations, that the MSP has had this client for five years, and the client is resigning an agreement. Does this change the valuation? Absolutely.

In both scenarios, one with a five-year agreement and the other with a monthly contract, a prior five-year relationship with the client would give any buyer much better predictability about the client remaining after an acquisition. The past relationship has greater weight than the future agreement term.

If you agree with this analysis, then perhaps it is time we rethink the practice of long-term agreements solely for the sake of having them. Your objective, as an MSP, should be the retention of your clients. A contract is not a retention mechanism; excellent customer service is a retention mechanism.

Tags : M&A,MSP agreements,MSP valuation
  • John
    Posted at 12:25h, 01 July Reply

    Well said Charles. I fully agree.

  • Brent
    Posted at 21:46h, 29 July Reply

    Charles, I just went through this with several PE firms. Of course, all were “concerned” that we STOPPED signing long-term contracts with clients over15 years ago. But once we showed them the tenure of our clients; they gave us an added multiple allowances on our deal. The groupspeak out there at HTG and True Methods, and other mastermind groups is that contracts are the number 1 valuation KPI, but it’s just not true. Sophisticated PE firms KNOW that our contracts are not enforceable if the client claims “cause” so what’s the point? Avoiding the annual or bi-annual “contract signing dance” is SOOOO worth not signing long term contracts as long as you are delivering. I’d be glad to share my experience with you if you would like to discuss it further. -brent

  • Charles Weaver
    Posted at 22:18h, 29 July Reply

    Brent – agreed. I think at some point it was a valid practice, but we’re now 25 years into this profession, I think it’s time we look at actual length of service to the customer, that says it all.

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