Rising M&A activity through the pandemic
The MSP industry has witnessed a steady rise in mergers and acquisitions. 2021 and early 2022 has been something of a landmark year in M&A deals for managed services, with over 1,000 such deals. M&A activity in this industry continues to show great promise.
For many MSPs acquisitions have become essential to scale their business operations, increase sales, expand customer base, and achieve exponential growth in a short span. Another approach to proliferating revenues is by combining small and medium-sized MSPs into a larger enterprise. MSPs are looking to merge their strengths and identify smaller players over a localized area to acquire these companies. This kind of acquisition is typically done to acquire customers rapidly. MSPs also look to acquire companies for the specialized expertise that their technicians offer. This kind of acquisition falls under talent acquisition.
MRR is an important factor attracting acquisitions
Recurring revenues are payments being made over a set period of time due to a customer’s ongoing subscription to a service. It can be daily, monthly, or yearly. In a recurring service plan, the customer keeps paying the service fee till they actively cancel the said subscription. Customer lifetime value and future revenue estimates are some metrics that can be calculated when a company is running on an MRR business model.
MRR or monthly recurring revenue is a benchmark for most business success. MRR gives tangible results and forecasts revenue anticipated over a period of time. MSPs are monthly recurring platforms and for companies acquiring MSPs, this is a very attractive revenue generation model.
Knowing how your company performs in terms of revenue helps keep you ahead of the curve. From the acquirer's perspective identifying a company’s MRR helps in strategizing their future sales plans, and other company expenses. Measuring the MRR gives them tighter control of the ebb and flow of cash flows and helps foresee easier budget allocations.
Private equity emerging as the frontrunner in MSP consolidation
Private equity has been a driving force for MSPs to scale up further. Market trends have shown that, over the past few years, private equity firms have been one of the front runners in funding, helping MSPs either merge or be acquired. Traditionally, the MSP marketplace is very fragmented, and private equity firms help in consolidating multiple smaller players into a larger one. Let’s take a look at some of the reasons behind this constant PE activity in this space.
One of the leading reasons is identifying multiple smaller players in a location and mass acquiring these companies to form one big strong player. MSPs can cross-sell services across different verticals, which could be a strong motivation for an investor who’s looking to specialize in a particular sector.
Recurring revenues as mentioned previously are another deciding factor. MRR gives you predictable cash flows, which is an easily measurable metric making it a safe bet for private equity players in this space.
Managed services also have a fantastic ability to scale. When managed services start taking on more customers they can grow at an exponential rate. Companies working with RMM can consider starting off on PSA functionalities, MSPs can hire more technicians, open another location, etc., to aid in the scaling up process.
Is the M&A activity curve flattening?
While M&A activities are still a constant presence in the MSP space, one can’t deny that the trend is gradually slowing down. Even though 2022 saw more than a thousand M&As, it looks like this year might see a drop in this trend. The trend isn't going to completely fall flat but it has cooled down.
A volatile economy and the slump in macroeconomic and geopolitical circumstances could be some of the factors contributing to this downward shift. 2023’s rising interest rates and fears of global recession are contributory factors in this downtrend.
But, the history of the last decade or so has shown that companies trying to cut costs, typically outsource their tech and other IT management services. With many companies going remote over the past couple of years, tackling security vulnerabilities will be at the top of the list for most enterprises. When companies start requiring help for other organizational functions but at the same time are cutting down on manpower, they can turn to MSPs to mitigate dependence on their workforce.
What factors should the seller keep in mind when considering getting acquired?
The MSP marketplace is constantly changing and digital developments along with companies transferring their data to the cloud make this business an appealing prospect for companies looking to acquire. From a seller’s perspective, you have to consider what rate you would be happy to exit at. How much money are you looking at from this buyout? What happens to your employees? These are some of the questions an acquirer should be asking.
Trends in the first quarter of 2022 saw valuations remain high with private equity funding also contributing to the shift.
What factors should the buyer keep in mind when considering an acquisition?
One main factor an MSP will naturally consider when acquiring a company is how profitable the business is. Another crucial factor to keep in mind is the business model of the company in terms of generating recurring revenues. The buyer should also analyze the reason behind the sale of the company. Some other factors to consider are:
- Recurring revenues
- Autonomous business model
- Diverse revenue streams
- A strong team
Aligning company cultures after acquisition
MSPs on the verge of acquisition will naturally have certain qualms regarding their alignment with the new company. One of the more crucial factors when considering an acquisition, from a seller’s point of view is can the organizations culturally align after integration. In principle, when a company is integrating with another, consolidating company cultures should also be a part of the M&A preparation plan. Early communication is key to mitigating cultural integration issues.
Employees are key to a successful merger. If we can actively analyze the working behaviors of the merging companies, then half the battle is won. Once the behaviors have been identified, then a set of rules can be framed within which both organizations can work harmoniously. Creating a detailed change and structured communication plan can help mitigate any risks that usually accompany the uncertainties behind M&As.
MSPs will continue to ride the M&A wave
In today’s environment, mergers and acquisitions might see a gradual slowdown. But recurring revenues continue to make private equity companies sit up and take notice of this market. And as long as MSPs have a clear, structured plan, track economic benchmarks, and prioritize company cultures, this market will continue to see mergers and acquisitions.