Dig into the MSP M&A process from the acquirer's perspective
MSP mergers and acquisitions may frequent the news, but how is the value of an MSP determined, how are deals structured and what happens to the acquired company?
Dave Sobel is host of the podcast The Business of Tech and co-host of the podcast Killing IT. In addition, he wrote Virtualization: Defined. Sobel is regarded as a leading expert in the delivery of technology services, with broad experience in both technology and business.
In this video, Sobel discusses all things acquisitions with Ravi Ramharak, managing director of M&A at MSP Corp, an IT services and consulting company. They discuss what investors look for -- recurring revenue, autonomous management and diverse revenue streams -- as well as the warning signs during a deal. Ramharak explains how investors value MSP businesses, get their return on investment and what to expect during an acquisition.
Transcript follows below. Minor edits have been made for brevity and clarity.
Dave Sobel: This time we want to talk about some of your recent announcements, because you're obviously with MSP Corp, and you guys have put together an investment group, which is focusing on bringing together MSPs, and it will roll up investment organization to make a larger MSP. You're backed now. You've had a recent $35 million capital transaction led by BDC Capital's Growth Equity Partners and did two recent acquisitions of some Canadian MSPs. That's what I wanted to talk about today. Let's start with your basic premise. In the press release around this, you said your pitch is a simple one: You're private operators buying private operators. Tell me a little bit more about what the strategy is to build this organization.
Ravi Ramharak: Great question. You look at every strategy right now, and they're all the exact same: Buy five or 10 MSPs, merge them into one platform in an area, make that the super MSP and then go from there. And then exit to somebody else and flip the investment. When you look at the industry as a whole -- and I've been around since I was 18 years old; I'm 35 now -- and the same clients have been employing me, believe it or not, that entire time. I look, and I'm like why are we selling, to who? We can just buy, we can build, and we can hold. We can have 30, 40 MSPs in a large group together. And where we add value, where we're working to add value is on the shared services.
What we first had to do was buy the MSP. We bought eight MSPs. They're all kind of ranging between the five to 25-person range. And what we did is we took a look back over the last six months and said, OK, where can we add value? Where are the shared services and accounting, legal, buying power, Microsoft [Cloud Solution Provider], cybersecurity backup, hosting, telecom, the eight core areas? We're working now to apply those to all of the groups so that the MSP has not only increased their organic growth through shared services that they're able to additionally sell to other their clients, they also have more skill set internally, that they don't have to hire externally for. [For] a 10-man MSP or 20-man MSP, even 30, to have cybersecurity people is very expensive, and they're not going to be that busy. Let's just face it; they're not. Having a centralized NOC [network operations center], for example, and being able to resell those services down or offer that value. Where I think our model is different is that we keep the brand autonomous from us. The staff know about the transaction. The owners obviously know about the transaction. All the vendors know about transaction, but the client never really knows. Because I believe that MSPs are regional businesses. I've always said this since day one. You got the CGI and IBMs, all the big guys -- they're doing national work, but really the MSP client is a regional company.
Sobel: I'll buy this premise for increasing the value on anybody who gets acquired. I get their value there. And I get the value in this model for MSP Corp, this expanding MSP itself. What I need to understand to baseline this is tell me how your investors plan to make money. Because if you're just going to grow this bigger MSP, at some point they want a return on the money they put in. How do you plan on delivering that?
Ramharak: That is a great question. Number one, 95% of investors won't like us because we're a long-term play. For example, BDC. BDC, we picked them to work with them because they have a long five-, 10-year horizon. They're not in this for a one-year return. For us, as we build up our revenue platform, you could potentially see us exiting to probably going public at some point. That's the most logical answer I would think, or just buy and hold. You've got great cash in all these businesses. These are not SaaS-based companies burning through revenue every month. They all generate 20% [earnings before interest, taxes, depreciation and amortization] EBITDA margins. I think from there alone, you have a great return. And I think when we pick our investors, especially the current one we're working with, it's 'what is your strategy in your fund?' If it's to come in and in three years, pick this up and go, it's not the right platform for us. If you have a long-term approach, for example, look at the recent deal [between Fully Managed and Telus]. It's not really announced, but you've heard about it. I've heard about it. Look at that transaction; for Telus, that makes sense. Telus is going to be here for a long time. To get into the MSP space makes sense for them because they have the platform to not only cross all telecom services. I think for us, there's lots of potential exit strategies through either public markets, through a telecom player, through a synergistic value player, where they would look at our market share and say, 'wow, if I have access to 50,000 small to medium businesses, what can I do with that at a larger platform?' I don't think we need to have a general private equity exit.
Sobel: I get that. Now let me push back a little bit because there's a big difference between a five-year exit and a 10-year exit. How comfortable are the investor group that you're working with looking at a 10-year return on investment?
Ramharak: I would say the way we picture right now is a five-year return on investment. And then we could look at a cumulative fund to recap and keep that going. I think almost every investor max is about five years. Right now, we're really focused on the five-year approach; get to the five-year mark and then reevaluate our position at that point and see which investors want to stay in long term. Again, this is kind of like ... you're almost buying a janitor or a plumbing or an HVAC business. They can just keep going for a very long time. For right now it's just five-year approach. That's the scale of economics that makes sense. And then let's look at the right investment thesis. At that point, what's the next step?
Sobel: I'm pushing because I keep telling my listeners, follow the financial investments to understand the motivations. I wanted to get some clarification in there. Let's make this practical for MSPs themselves who are thinking about the valuation of their business. Tell me about how you are valuing the businesses you're buying.
Ramharak: One of the big things about us is that because we're a creative buyer, we're very niche in the MSP space. I look at three major things: recurring revenue above 50%, ideally contracted if possible, like one, two, three auto renew; management that's either the owner himself or herself, whoever it is, is in place but not managing the business and, in an ideal world for our acquisitions today, the ownership is in a senior position, but they're not really doing a lot. They mostly are like there to pay homage to the brand, but they've got their business running autonomously. That adds a lot of value. And I think third and most important one is they have diverse revenue stream. I don't want to see 90% hardware or 90% project. I'd like to see 50%, 60% managed services, 20% project, 10% cyber, 10% hardware, whatever the mix is, some diverse revenue stream. Those will be the three biggest ones for me.
Sobel: Now I'm going to push a little bit again here too, because look, the one thing I'm pushing back on is all the time you read about these deals and they all end with the line, financial terms were not disclosed. No one has the ability to actually understand anything about the deal. You've done two deals recently, and I'm not asking you to specifically tell me exactly how that works. But be a little more specific about how is the deal structured in a way that a potential owner would understand, 'okay, I've got a range of how much my business is worth.'
Ramharak: Yeah, sure. You know what? I'll give you the exact number for us. And I think we're pretty industry standard. Your reader can take it with a grain of salt. If you have EBITDA, let's say adjusted EBITDA -- which your accountant can help you do -- of around $400,000 to $600,000 Canadian dollars, you're going to trade in roughly the 5 to 6.5 EBITDA range. You're probably going to get 3x to 4x upfront in cash, and then you're going to get the rest probably in some sort of earn out structure, one or two years, with some sort of EBITDA target so that the new buyer has you kind of transition yourself out. Or if you're staying longer term, you might keep a longer hurdle with a higher payment for yourself. I would say again, that's the multiple for me I would see kind of going forward.
If you're $600 [thousand] EBITDA to a million EBITDA, you're going to trade between 6.5 to 8.5 EBITDA margin, depending on how good your revenue is. And that's going to come down to those three factors I mentioned earlier when you asked me. And then if you're trading above $1 million dollars in EBITDA, you can get anywhere from, I've seen 5x deals because the clients were really bad and the business poorly run, to 12x deals, so kind of all over the place.
Sobel: You've given some gaining criteria. Is your intention with the ideal deal to retain leadership or let them exit after a payout?
Ramharak: In the ideal world, they stay on board. Here's what I'll tell you. What I found with 99% of our owners, the minute they get that check, the stress is gone. Not every owner. We have some owners that are 65 that are retiring; They're on their way out. But for the majority of younger guys in their thirties to fifties … I mean, look, including myself, I don't have a lot of skills. I've been doing the IT business for half my life. It's not like I can go start [another kind of] company tomorrow or go open up a restaurant. I don't know how to do that. So for me, [and] I think a lot of guys, when you take the stress of the sale away, they get to really do what they love again. And most guys are staying on board long term.
We had one more who was adamant of leaving and after two years together, he just signed another one-year contract and I don't know, the love for the industry comes back to what it originally was.
Sobel: What's the smallest entry level that you'd consider from an acquisition perspective?
Ramharak: When we first started it was very different. We were in $300,000 to $400,000 EBITDA range. I would say now, today -- and this is my recommendation for anybody -- don't sell until you're over $500,000. Because a lot of the systems you need, you haven't done them yet. What happens is the buyer's going to take you for a big coupon. Look, we want to pay top dollar for a business. And I'm even nurturing eight MSPs right now over the last two years to build a better business. I have my own kind of private nurture where I'm helping them every year look at their financials, look at their books and help them mature their business. We're happy to pay them top dollar, but a lot of times $300,000 to $400,000 EBITDA, you're going to get really chomped on value.
Sobel: Now give me the biggest warning sign that you'll see from when you start looking and doing due diligence on somebody that once they've checked the check boxes for your minimum numbers, what's the next thing that would instantly say, 'oh yeah, this is not the right deal for us.'
Ramharak: Client concentration.
Sobel: OK. Elaborate.
Ramharak: If you have a client that takes up 20% to 30% of your revenue, your value drops by half right away for everybody. Change of control clause post-close, you don't know what that client's going to do. I would say that's the number one thing that kills every deal I've looked at. We've gone through the first stages. We haven't gone through the client list yet. And when we do, we're like, hold on a second here. There's this one client that's got a really big number for you. So that's number one. Number two that's going to really kill you post-close is on finding out the areas that your clients are in. If you're in retail or hospitality, you got to start pivoting those clients out and start to get into the more small business, medium business, healthcare and that kind of stuff. I think those are the two big things that kill you.
Sobel: All your deals so far have [been] Canadian, right?
Ramharak: That's correct.
Sobel: And for 2022, you're looking to break into the U.S. market?
Ramharak: By mid-to-late 2022, we'll be in the U.S. market.
Sobel: How many deals do you think you're going to try and do?
Ramharak: Oh, Dave, tough question. I can't tell you that. I would say this year, I think we'd like to do five, 10 deals. I think 2023 we'll be wrapping up a lot. Our vision internally, just so you know, is we want 50 deals in 50 states. It sounds crazy, but that's the model we want. We've done that in Canada, and now we want to do that in the U.S.
Sobel: Well, Ravi, let's give the listeners a last little tactical bit. If somebody is thinking about this, what would you advise them to do first to get ready to be serious about an acquisition discussion?
Ramharak: I would say, first of all, my email is always open. If you're three years ahead of where you need to be, send me an email, send me a link to ask me. Here's why: I was an operator first and foremost. Today I'm a buyer, but for 17 years, I was an operator. I understand the difference between selling your business for 10x and getting 3x. And I could tell you a five-minute phone call will save you a lot of time. That's my personal suggestion. Outside of that, I think companies like Service Leadership, they publish some great data. If you're really wanting to be a top-tier MSP, it's a little bit expensive if you're starting off. But if you join Service Leadership and really use their metrics, you'll probably build a very good business long term that investors will like.
If you're too shy to talk to me, too shy to talk to anybody on our team, there's great guys like Evergreen out there you can talk to. There are mature companies like F12 you can talk to. Reach out to your peers. All of us essentially started in the MSP business. I think we'll all have advice to give you. And I don't feel like anybody's too predatory. I've talked to every big buyer in this space over the last two years and even within us we share information. I think it's a very non-predatory space.
About the author
Dave Sobel is host of the podcast The Business of Tech, co-host of the podcast Killing IT and authored the book Virtualization: Defined. Sobel is regarded as a leading expert in the delivery of technology services, with broad experience in both technology and business. He owned and operated an IT solution provider and MSP for more than a decade and has worked for vendors such as Level Platforms, GFI, LOGICnow and SolarWinds, leading community, event, marketing and product strategies, as well as M&A activities. Sobel has received multiple industry recognitions, including CRN Channel Chief, CRN UK A-List, Channel Futures Circle of Excellence winner, Channel Pro's 20/20 Visionaries and MSPmentor 250.