It’s a seller’s market, but MSP valuations are too high

It’s a seller’s market, but MSP valuations are too high

Business owner price tags out of sync with true market value

Arlin Sorensen (ConnectWise)

Arlin Sorensen (ConnectWise)

Credit: ConnectWise

Managed service providers (MSP) are well positioned to pursue a sale process in a market dominated by buyers, but remain hampered by unrealistic valuation expectations.

Such misalignment - coupled with a buyer heavy approach - has resulted in business owner price tags being out of sync with true market value.

“The biggest challenge for a selling business is an unrealistic expectation of value,” observed Arlin Sorensen, vice president of peer groups at ConnectWise. “MSPs think they are worth far more than a buyer does and that can be a roadblock.

“A buyer evaluates based on the ability to actually pay for the business, rather than how hard these guys have been working or for how long. You just don’t get credit for longevity or hours worked when you go to the market, people don’t pay for that.

“They pay for profitability and consistency over time so that is definitely the biggest roadblock for partners and today, that gap is the highest it has ever been.”

Speaking to ARN during IT Nation Connect in Australia, Sorensen acknowledged that even though valuations might miss the mark, selling MSPs still may find a suitable buyer due to the high demand for services businesses.

“MSPs think their businesses are worth way more than they really are but we also have a lot of uneducated buyers that are paying way more than they really should,” Sorensen added. “There’s an artificial market today simply because of the number of people wanting to engage in M&A.”

As a case in point, Sorensen cited the Deal Crawl event held during IT Nation Connect on the Gold Coast, in which buying MSPs outnumbered selling MSPs by 27 to five.

“There’s a frenzy of people that want to buy which drives unusual behaviour,” Sorensen said.

In assessing the channel, Sorensen said business owners thinking of pursuing an exit strategy should create a “three-year runway” to prepare the company for sale.

“Before you try and get that deal closed, take the time to get your financials in order and processes documented because they are usually not written down anywhere,” he advised. “Prepare your business to sell so that when the time comes, you can make the best pitch of your life.”

Regarding the transactions specifically, Sorensen said timeframes can range from a “few months to six months”, with the latter being the most typical timeline.

“But this is a seller’s market filled with a lot of buyers, and I know of one MSP that closed a deal in two weeks,” he added. “Most of the sales I see are relationship sales, they are people that have met people at events or communities, we see a lot of those deals going on.

“Those deals usually go faster because the due diligence is not as intense. The most successful transactions are through the network.”

Closing the deal

According to Sorensen, MSPs across the world are gearing up for an era of ownership change as the channel edges towards an all-out M&A frenzy.

Specifically, 70 per cent of MSPs are expected to explore buying, selling and merging options within the next five years with industry consolidation on the horizon.

“I don’t think M&A will slow down,” Sorensen said. “We’re in a bubble in terms of pricing, the multiples are way too high and I do believe that the pricing will come down in terms of what people are willing to pay.

“But the stage we’re at in the industry regarding maturity, acquisitions are a big part. Consolidation will continue and we see that on both the vendor and partner side.”

Sorensen also outlined a trend in which the buying company is asking the owner to leave almost immediately after the sale, moving away from an era of “golden handcuffs” in the process.

“We’re seeing a lot more clean breaks,” he added. “If the owner is still around, then the staff that they brought will still go to him or her for direction first and that can create problems.

“Usually, there’s not exact alignment with the new direction and approach of the new company, and the owner can actually become a stumbling block in that sense. We’re seeing more instances of the owners being kept around on a contract basis to provide advice as needed, but they are not kept in the business from a day-to-day perspective.”

On the flip side, Sorensen said most deals fall over due to the buying company underestimating the integration process, and in doing so, neglecting key focus areas such as staff and customers.

“The actual deal is the easy part, it’s getting the integration done that is the challenge,” he explained. “Taking care of colleagues and customers is crucial and having a former owner in the mix can really muddy that process up and slow strategies down.

“There’s an assumption that staff will pick up the vision of the company because they are literally in the building, but that never works. In most cases, processes aren’t documented so employees don’t really know how they do business, they just do what they always do.

“So, if you come in from the outside to an organisation lacking in documentation, it takes forever to figure out the correct way to do things.”

In short, Sorensen said integration is the “secret sauce” of a successful M&A deal.

“But buyers don’t place any budget or investment into integration,” he cautioned. “Deals don’t necessarily fail, but they often don’t live up to the expectations set and that’s because of the integration.”

James Henderson travelled to IT Nation Connect as a guest of ConnectWise.

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