One thing about our current economic situation is that it is forcing good people and good MSPs to have to make hard choices. Since late 2008, I’ve witnessed a lot of companies go through some difficult times; while the managed services industry continues to grow there are still hard times and choices ahead of us. While the decision to sell your company is aways an important one, having the right facts is critical to making the right decision at the right time. Here are some things everyone should be thinking about at this point in our economy.
Lenders aren’t Lending: whether it is the new financial regulation law or skittish banks, traditional lending sources are less inclined to make loans to businesses. Even healthy MSPs are reporting more difficulty getting loans. This is causing otherwise healthy MSPs to have to restrict their growth due to lacking resources.
Taxes are going up! Next year, unless congress acts, the so called Bush tax cuts will expire, allowing the marginal rate, capital gains, and a slew of other individual and corporate tax rates increase. It’s no secret that increased taxes on MSPs will only serve to stifle growth and prosperity in this industry.
Increased Regulation: regardless of whether you approve of the recent laws passed in Washington D.C. it is unmistakable that buried within these laws are regulations that will cause MSPs great hardship to comply with these often complex and difficult to understand rules.
As the healthcare, financial reform, and other laws come into effect, only then will we truly understand their true impact on businesses large and small. I am asked more frequently each day by MSPs about whether they should sell their business. Honestly, the answer for each person and company is different. What is true for everyone, however, is that each MSP must have a M&A strategy in place should they need it. Do you have a M&A strategy for your business?
I recently had a conversation with someone and the subject of M&A came up, specifically what the current valuation trends were. Having been in M&A for so long I have seen this particular area of business philosophy mature in many respects. Many MSP’s, during the negotiation process, would complain to me about why their businesses were being devalued by potential buyers. Obviously, that’s what a buyer is supposed to do; every buyer is looking for the best deal possible. However, in the last few years I’ve started to see a trend in valuation schemes that is showing signs of maturity and common sense.
Because M&A is the most likely liquidation (or cash out) event a business owner/investor is to experience these days (IPO’s, venture capital, and other deal transactions are less common) the valuation of a company is one of the best external indicators of how the managed services profession is faring. Here is a great example of how our profession has advanced in the last decade.
It used to be common practice to discount or assign a zero value to a MSP’s non-recurring revenue…zero! This means, any product, project, or any revenue of any kind that was not specifically tied to a contract would have been essentially tossed out of the negotiations. What ended up happening was recurring revenue (tied to a contract for all of you “we do business on a handshake” folks) was valued at a premium, with its own multiple, while the non-recurring revenue was assigned a zero or minimal valuation multiple. I actually got very upset and decided to quit the M&A industry because it was unfair to the MSP’s who worked hard on growing their business only to see important components of the business thrown away at the bargaining table.
Today, things are beginning to change. By going to a flat multiple scheme, MSP’s can achieve a more realistic and accurate model of their business valuation than under the previous model. For example, instead of taking all the different revenue sources and assigning each its own multiple, you would take the overall (top line) revenue and assigning it one multiple. Assuming that the revenue streams are all related to a managed services practice (i.e., you wouldn’t want to pay for a tanning salon along with the MSP business assets) this valuation model will yield a number more accurately reflecting all the various components that make up a successful and efficient managed services practice.
Our profession is maturing and for that I am thankful! What are your thoughts?
The subject of valuation models for MSPs is coming up in discussion more frequently and I see a lot of people with hugely different valuation multiples; so many that I though I’d clear the air. The first thing everyone must understand is there are valuation models that favor buyers and there are models that favor sellers. Because these models almost never yield the same number, we are forced to create a third model that more closely approximates the true value of a managed services practice (for those of you who want to skip to the end and see what that model is…come to the M&A Workshop on February 4).
One of the inconsistencies of a “buyer’s” model is that it relies heavily on EBITDA. I say this is a buyer’s model because it assumes a MSP has net income. When most small MSPs run their practice as close to breakeven as possible (to minimize tax exposure) this EBITDA number tends to be very small. Therefore, a buyer will generally have a lower price with a EBITDA multiple.
On the flip side, a seller tends to favor a top line revenue approach as this number will exclude profitability and focus on their ability to generate revenue. Naturally, this excludes some very important operational factors and will never produce a very accurate valuation number.
Therefore, I have created a blended approach that takes into account both top line revenue and EBITDA, as well as many other operational factors to produce a very accurate valuation for the MSP practice. In the end, no matter what people are saying the going multiple rate is in managed services, if a bank won’t finance it or an accountant can’t wrap their head around the valuation number, it probably isn’t a very good valuation model being used.
Yeah, buyers want to buy MSPs cheaply and sellers want a lot more than they are worth. Somewhere in the middle the truth can be found. Oh, and come to Dallas, TX on Feb 4., we’ll be going into a lot more detail about this model during the workshop.
