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.
