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Oct. 3, 2022

Top 10 Value Drivers for Managed Service Providers MSPs

Top 10 Value Drivers for Managed Service Providers MSPs

As the founder/owner of a Managed Services Provider (MSP), it’s important to know the value drivers that should inspire your business strategies -- whether you plan to sell today or in the future.

  • Revenue Growth: While demonstrated revenue growth and a solid pipeline will lend itself to higher valuations, the quality of that revenue growth is also important. Growth in the rearview mirror is the price of admission to enter discussions, but buyers care most about what happens after the acquisition of your MSP. Monthly recurring revenue (MRR) growth is the most important factor with non-recurring revenue tied to MRR clients acting as a bonus for buyers. The ability to grow quality revenue streams demonstrates ownership of customer, defensible position, and meaningful wallet share. And unlike standard IT services businesses, buyers of MSPs expect annual growth to exceed 15%.
  • Gross Margin: Gross Margin is one of the most important lines on your P&L and is the way buyers measure how efficiently your MSP makes money. An ideal gross margin target is 50%+ with the ability to maintain or increase that number while growing revenues. Buyers of MSPs will evaluate the consistency of month-to-month gross margins in order to understand how much of every revenue dollar flows to the bottom line. A consistent gross margin above 50% demonstrates good quality of revenue and bill rates versus cost. It’s the best starting point toward achieving an optimal net profit. And with cash flow being critical to growth and sustainability, higher gross margins directly affect cash flow.
  • Customers: Customer loyalty and concentration are key to growing your MSP strategically.

    Loyalty: The value of your MSP is often predicated on the stickiness of your customer base. Buyers will evaluate the retention and churn rates of your customers as well as the revenue tied to each account. Achieving a +90% retention rate for MRR clients is a strong indicator of service quality. Your firm’s churn rate, which is the net of new customers versus lost customers, will also be a key attribute of a buyer’s evaluation. Seek to demonstrate stability, strong relationships, and low turnover. 

    Customer Concentration: Avoid heavy concentration from only a few customers, with no one customer representing more than 20% of your total business. During the process of selling your MSP, a loss of 10-15 percent of your revenue (e.g., one customer) can be the difference between profitability and break-even. If your largest customer represents 25-30 percent of your total revenue, buyers will be reticent about acquiring your MSP. The answer is not passing on large customer opportunities, but ramping up business development efforts to dilute the total percentage of that new large customer.

  • Predictable Cash Flow: All buyers want to mitigate as much risk as possible before pulling the trigger on an acquisition. High recurring revenue models solidify predictable cash flows and demonstrate a sustainable business. For MSPs, MRR and ARR is the income that will be received every 30 days or annually based on collecting subscription fees for services rendered. Buyers love steady cash flow vs. the traditional IT services model that is lumpy due to fluctuating project-based assignments. MRR also demonstrates a scalable model for continued growth, simplifies expense management (easier to increase or reduce expenses to match revenues), and provides excellent visibility based on a durable forecast.
  • Growth Markets: MSPs are among the fastest-growing IT sectors today. They join cloud services, mobile, SaaS, and data as the most sought among private equity and strategic buyers. Sellers of MSPs need to be ready to present a growth plan of actionable and justifiable ideas to potential buyers. According to a report by Mordor Intelligence, the Global Managed Service Provider Market was valued at $152.05 billion (USD) in 2020. The market is expected to grow to $274.20 billion by 2026. This implies the relevance and adoption of managed services are here to stay. Buyers of MSPs recognize this potential for continued growth as more businesses digitize their processes, streamline support, and implement more software platforms for efficiency and continuity. Within the MSP space, data security remains white hot. Our firm continues to see MSPs acquiring MSSPs to create a one-two punch offering. When combined, this increases the odds of a higher valuation upon exit.
  • Proprietary Technology & Intellectual Property: IP is one of the strongest barriers to competition and the secret sauce for which buyers are willing to pay a premium. Comprised of trademarks, patents, copyrights, or a developed process, IP can be the ultimate differentiator when buyers are looking for scalability and margin growth. In many cases, a target company’s IP is the most valuable piece of an acquisition. For all buyers, they have three choices relating to IP: Buy, build, or partner. As MSPs continue to innovate, they will be rewarded by distancing themselves from commodity services.
  • Management Depth & Culture: Create a reputation for attracting and retaining top talent, and be recognized as a great place to work. Have a top-shelf “second in command” executive — with a low reliance on any one person. Employee retention and long average tenure is a positive in the eyes of buyers because it demonstrates stability, good culture, and deep knowledge. Strength in management and employee retention translates to long-term customer retention, which mitigates some of the buyer’s risk. Whether it’s vacation policy, dress codes, or the firm’s purpose, the culture of a target acquisition matters to buyers. According to a McKinsey study, “A deal can create an opportunity to upgrade talent across the organization; in some cases, gaining access to highly skilled employees is the primary reason for an acquisition. Conversely, mismanaging talent issues can seriously affect the success of even a relatively straightforward transaction.” Bottom line: Buyers need to understand the in-house talent, and be confident they will remain following the sale.
  • Digital Infrastructure: According to a PWC study, more than 25 percent of all CEOs considering M&A say their top driver “is to acquire capabilities, including technologies. And it doesn’t necessarily have to be a big deal. In some cases, smaller transactions can help companies keep pace with innovation and bring change down the road, even if not considered ‘transformational’ at the outset.” This includes smart back office systems, even if you are running small business software packages (e.g., QuickBooks, Xero, Wave, etc..). Ensure your books are in order and invite your accountant to do a stress test on your ability to provide large amounts of data for the due diligence period.
  • Brand & Reputation: Brand recognition for your MSP has many layers based on the various audiences you are reaching. A well-defined brand includes the firm’s name, logo, colors, symbols, mission/vision and messaging. From a buyer’s perspective, value is derived from your brand/reputation based on what the marketplace is saying, the quality and frequency of your external communications, social media, and even customer feedback. While it takes years to build a strong brand, any damage to your MSP’s brand lives ad infinitum on the internet. (PS: If most of your new business comes through word of mouth, your brand may be strong, but a dedicated business development professional could grow your revenue -- and corresponding value -- by multiples).
  • Scalability for Growth: All buyers project various growth scenarios before making an acquisition. To mitigate risk, buyers of MSPs need to feel confident that the target acquisition can scale. Can you take on increased workloads in a cost-effective way, without burning your employees out or failing in execution? A solid operating system, use of automation tools, proven business procedures and a balanced bench of delivery personnel create an environment capable of handling growth. In many cases, a scalable business model creates a platform for additional acquisitions. These platform MSPs subsequently trade at higher values.

Looking for more information? Curious how this applies to your MSP? Visit www.itexchangenet.com/marketplace-how2exit