Entrepreneurial dreams come in many forms. Some start a business for the freedom it allows them. No boss, the ability to set their own rules and, in many cases, the chance to create something unique, useful and invaluable. Those who build businesses based on those ambitions typically receive more intrinsic rewards. While they expect a certain level of financial return, anything above and beyond is just “icing on the cake.”
On the flip side are entrepreneurs who treat their business like a project. The end game is to maximize the return on investments and turn a tidy profit. That might take two years, or a decade, but the ultimate goal remains the same: get the company in the black ASAP and cash out at the optimal market value. Metrics and timing are the two key factors to success. Those who run their business like a business, and catch the market at a high when their profits and cash flow are trending positively, are more likely to hit the jackpot. There are no guarantees, so “financial entrepreneurs” may not take the same risks as their “lifestyle” counterparts, which can limit creativity and growth options.
The vast majority of channel companies I’ve encountered over the years fit into the former category. Many VARs and MSPs start out working for other IT firms or end user businesses as technicians or engineers, and for a variety of reasons end up going off on their own. Some get tired of dealing with corporate rules or overbearing bosses. Others simply have an idea or see an opportunity they can no longer overlook. They put out their “shingle” and get to work, often building their organizational structure as they go. Business processes came slowly as the customer count climbed. That type of organic growth is what drove so many channel success stories over the last two decades.
And all the activity back then is one reason why M&A activity was so strong in 2016 and will likely remain that way for the next few years. The channel is maturing. When combined with the growing population of “financial entrepreneurs” in the IT industry, the number of prospective business sales will continue to escalate over the next few years. The question many are asking is if the demand will keep up with the supply. MSP business valuations are quite high right now, but if investor dollars begin to dry up, will it be worth selling?
Timing is Everything
As of January, 2017, few industries are as ripe for an infusion of venture capital and other investments as IT services. VARs and MSPs are driving business innovation, and the technologies and services channel companies deliver will be needed regardless of the economic conditions. As sales increase, companies often invest in innovations to scale and better compete. In economic downturns, businesses typically look for solutions that reduce costs and improve customer satisfaction levels. That equation may not hold up if market conditions deteriorate significantly, but few expect that to happen and profitable IT firms with secure long-term contracts should remain attractive acquisition targets in 2017.
The secret to a high valuation? Cash flow. Not just the past twelve months, but a track record of increasing profitability and a growing number of customers under long-term contracts. Buyers, whether venture capitalists or other IT services firms, pay for past performance and positive trends. An MSP with five years of 7-10% profit increases growing customer count by 10% annually will attract more interest than a peer company that achieved a 25% profit in 2016 (but was in the red the two previous years).
Long-term contracts with firm financial language that favors the MSP are an M&A insurance policy. The most valued component of an IT business is its cash flow, which is hugely impacted by its managed and cloud services portfolio. The greater the assurance that that recurring revenue will be there in 2-3 years, the more valuable to organization will be to potential suitors. Consider the case where a company’s valuation is high based on all the financial metrics. If 90% of their client contracts are due to expire in the next 12 months, the offers would likely be far below that expected rate. Timing is key, so they’d be better off waiting a year to sell while getting those customers into new, long-term contracts — preferably at a higher profit margin with stiff opt-out penalties).
Another major factor in determining when to sell your business is personnel (including owners). If you stepped away, would the organization run seamlessly? Would revenue continue to grow and existing contracts be renewed with similar (if not better) terms? The answer to each of those questions doesn’t necessarily have to be “yes.” It depends on the buyer’s expectations. Some may value an operation they could simply merge with their own practice, and may not want the old management team messing it up. Others might rely on your expertise and pay more for continuity.
The same hold true for key employees. Would your tech or sales “superstars” be willing to stay on if the business were sold, at least during the critical transition period? That answer will likely depend on the acquirer’s plans, but if your team is willing, if not eager to adapt to change, they’ll give new owners the benefit of the doubt. That increases your options for selling the business — as well as its value to certain prospective buyers.
Those are just a few of the factors that influence channel business valuations. Be sure to check out the new CompTIA Quick Start to Mergers and Acquisitions for a more detailed discussion, including expert advice for optimizing value and simplifying M&A transactions. If you want the straight story from peers and respected channel experts on what it takes to sell your IT services business, download and review this free but high value guide.
**Recommendation for any MSP M&A transition plan: be sure to discuss the value of attaining a CompTIA Membership with the new owners. Not only will they gain access to a wealth of resources that will improve their chances of success by joining the IT industry association, but they’ll get the opportunity to network with a variety of channel professionals around the world. Be sure to get them off to a great start!
Brian Sherman is Chief Content Officer at GetChanneled, a channel business development and marketing firm. He served previously as chief editor at Business Solutions magazine and senior director of industry alliances with Autotask. Contact Brian at [email protected]
