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MSP valuations hang tough in turbulent market

Resilient MSPs are seeing their valuations holding steady through difficult times, although deal structures have shifted somewhat during the pandemic.

Although MSP valuations have remained largely stable despite the COVID-19 economy, the terms of some deals have shifted to mitigate the risk to buyers.

Mergers-and-acquisitions advisors, investors and service provider executives speaking at the IT Nation conference this week said the pace of M&A activity has picked up sharply after deals were canceled or delayed in the early days of the pandemic. The momentum is expected to carry over into 2021.

The continuing interest among investors underscores the resiliency of the MSP sector, which has suffered less than other industry segments due to its focus on remote service delivery and recurring revenue. Customers looking for cloud adoption advice have also boosted MSPs' prospects.

"The MSP market, as we look at it going forward not only from a velocity perspective [but] from a market resiliency perspective, has been really strong and getting a lot of attention from investors and strategic buyers," said Reed Warren, founder and CEO of IT Valuations, a Lino Lakes, Minn., company. IT Valuations provides certified business valuations as well as buy-side and sell-side representation.

Warren said he has seen a lot of private equity coming downstream, funding sub-$5 million acquisitions. Some of that private equity investment is funding MSP platform acquisitions, as firms look to purchase service providers to serve as the foundation for creating larger businesses.

The staying power of MSPs, and the IT sector's performance in general, has kept company valuations steady.

Valuations have stayed fairly constant because of how well the IT industry has done.
Reed WarrenFounder and CEO, IT Valuations

"Valuations have stayed fairly constant," Warren noted, "because of how well the IT industry has done. So, we haven't seen a real change in valuation as a multiple of historical EBITDA. 

Valuations dropped during the previous recession but not during the pandemic-related downturn, according to Paul DippellCEO at Service Leadership Inc., a consulting firm based in Plano, Texas, that provides a benchmark of solution provider financial performance.

"I think 2021 is going to be a pretty good year for solution providers and for MSPs," Dippell said during an IT Nation panel discussion on North American M&A activity. "I think valuations will remain the same."

One M&A change wrought by the pandemic involves deal structure. MSP acquisitions that had been conducted primarily on a cash basis in late 2019 became more heavily weighted to earn-outs. The earn-out portion of the purchase price depends on the selling company's post-acquisition performance.

"People are a little bit risk averse [about] putting big chunks of change down," Warren said. "They want to do a shared-risk model."

"When COVID hit, buyers switched to a much more risk-mitigated deal structure," Dippell noted.

But sellers' rejection of the new terms has caused buyers to reconsider earn-outs. "People are getting back into the market with a much less risk-mitigated approach," Dippell said. "I think deal structures will move back towards a more favorable balancing of the buyers' and sellers' needs, versus risk mitigation on the buyer's side."

Service providers, meanwhile, report more M&A opportunities coming their way. Vince Kent, president and CEO of cloudIT, a technology services provider based in Phoenix, Ariz., said acquisition discussions that were put on pause when COVID-19 hit have dramatically ramped up in recent months.

"Now it's getting to the point where we have multiple opportunities that we are working through and trying to decide which one is the best one," Kent said.

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