M&A For MSPs: A Competitive Weapon For Success
By Mike Williams, Logically
Managed Service Provider (MSPs) continue to be popular targets for investment, with merger and acquisition deals still being very active despite the impact of the pandemic on the economic landscape. In fact, 2019 was a record year for merger and acquisition (M&A) activity in the MSP space. This year's deals mark a continuation of the high level of merger and acquisition activity that characterized the MSP market in recent years. And, surprisingly, we have not seen recession fears significantly impacting deal flow.
In addition, Work from Anywhere (WFA) has changed our customers’ work practices dramatically and MSPs are uniquely equipped to support these changes by providing technology, connectivity, and security. In particular, technology solutions providers play an even more critical role in helping small to midsized companies succeed in the WFA world. These seismic changes are indeed opportunities for us. A recent internal survey showed that 95 percent of our employees wanted to work remotely 3 or more days a week, so COVID has completely changed our space as well.
As one of the nation’s fastest-growing MSPs, Logically has continued to be very active in the M&A space. We are expecting to close three more acquisitions before the end of this year (in addition to another three under current integration). With 15,000 MSPs across the nation, we are looking for the strongest partners that will help us continue to grow with the best people, products, and processes.
What’s The Deal?
If you are considering making an acquisition or being acquired, you need to know that the current environment is affecting deal structures. Whereas in the past (before March of this year), the M&A market was red-hot, since the COVID crisis, the market has slowed down a bit, but it is still quite vigorous by any standards. Before COVID-19, MSP acquisitions saw next to no earn-outs with very high valuations. Since the pandemic has introduced risk into the scenario, we are still seeing high valuations but on average the amount and length of earn-outs have increased. This is, of course, reflective of the risk inherent in today’s uncertain overall economic outlook. At our company, we see every change as an opportunity for improvement, and in that light, the COVID-19 crisis is an instrument of change that puts solutions providers in a unique position to grow. We are looking for MSPs with a history of year over year sales growth, healthy profitability, low customer churn, and a high percentage of recurring revenue so that each time we add a partner we grow faster together. Logically strengthens existing local customer relationships by providing the advantages of a national company – a wider range of services, a deeper senior engineering team, certified security controls, higher operational maturity, and better pricing through economies of scale.
How To Finance The Deal
How should MSP’s think about fueling acquisitions? If you want to become a platform and be targeted for PE investment, you likely need to be over $25 million in revenue, which excludes 99 percent of MSPs. For most of us, deals are funded via a combination of bank loans and cash reserves. Companies develop an inorganic growth plan and start saving to reduce the amount that needs to be financed. Earnouts help reduce the amount of loans and cash savings by funding a portion of the deal via the cash flow of the acquisition. The bad news in today’s environment is that although earn-outs are increasing, they are still a small portion of the overall deal structure. Another strategy to reduce borrowing is to allow the incoming owners to roll over a portion of their equity into the stock of your organization.
A great way for MSPs to cut their teeth in M&A is to target small local competitors. MSPs with less than $1.5m in revenue have lower valuations, and these deals can often be structured with very little money down and a commission on the revenue generated over two years. This model adheres to the best practices of not starting M&A by buying companies more than 20 percent of your size and farther than one hour away from your headquarters. These small deals allow you to develop your processes and integration team before targeting bigger fish.
Great Partners Are Key
Whether you are the acquiring organization or are considering being acquired, the key to a successful M&A is finding a great company to partner with. We believe that valuations should be driven based on the quality of the company. The most difficult task of bringing companies together is cultural integration, and it is the leading cause of M&A failures. As technologists, we often focus on system integrations, but investing resources in understanding the cultural difference of each organization and the best approaches to uniting them will produce a high return on your investment. Experienced consultants are specializing in this, so this is an area where you probably do not want to go it alone on.
Integration Management Office (IMO) – If you have decided to move forward with an M&A, MSPs mustn't “add in this enormous task into the job description of existing staff – At Logically, for example, we now have a dedicated Integration Management Office that specializes in M&A integrations. If you don’t have additional or outside resources to help with an acquisition, the amount of work that your staff will have to undertake will be enormous. It’s a recipe for disaster because it grinds staff, reduces EBITDA and it can turn into a bad cycle. You need a dedicated integration office (internal or outsourced) along with trusted advisors.
Over Communicate - Before, during, and after an acquisition, it is extremely important to over-communicate. Otherwise, people will answer their questions, often negatively. Consider adding a core value around communication to your company. We know that confidence in our company has dramatically increased during COVID because of our increased focus on communication and collaboration tools. The same rules apply during an M&A when there is a tremendous amount of change and uncertainty floating around.
Keeping Key People – The golden rule is don’t disrupt the staff or the customers. Look for companies with a strong team and continue the local leadership for that location as a dual role in the acquiring company. It’s important to make sure that you have strong employee engagement throughout the process.
Grow up Quickly – During my first acquisition, I broke every rule. For example, we bought a company that was 60 percent the size of Logically, and over an hour and a half away. Although the acquisition turned out to be a success, we realized early that we needed a plan that forces us to increase our operational maturity. You must have that plan and strong processes in place at your company before you think about bringing other companies into your organization.
Final Thoughts
Less than a decade ago before we started our M&A journey Logically was under $3.5 million in annual revenue, and today our run rate is over $60 million. In 2018 we brought on our private equity partner, the Riverside Company, to fund our aggressive five-year growth plan. In a little over two years, we have surpassed our five-year M&A growth targets and have no plans of slowing down. Our M&A activities are accelerating. As we go forward, we are looking for great companies that value trust relationships, share our core values, and want to provide more career development opportunities for their staff. Whether you are looking to join forces with a platform or grow your own company via M&A, this is an amazing environment for technology solutions providers to grow and prosper.
About The Author
Mike Williams is Chief Strategy Officer at Logically.