Here Are 5 Things To Know When Selling Your MSP: Expert
‘When you sell a business, don’t just think about the price that you’re selling for. Think about your net working capital in there, and that’s hard for a lot of business owners because working capital is the accounts receivable minus the accounts payable,’ says John Holland, managing director of Corporate Finance Associates.
When MSPs are looking to sell their business, many factors come into play. Whether it be getting account statements in order, valuing the business or building out a top-notch management, there’s a lot to consider before going to market.
John Holland, an investment banker, spoke to MSPs this week about what to expect when selling their MSP and what to prepare for when getting ready to sell.
“If you’re selling a business, you need to understand what’s in your heart,” he said. “If you want to just retire and move off, then a strategic buyer is perfect for you. If you’ve still got fire in your belly and you’re passionate for business, then a private equity buyer is the path to go because you can stay involved and grow the business together with a financial partner.”
Holland, managing director of Corporate Finance Associates, spoke at the XChange NexGen 2023 conference in Houston this week hosted by CRN parent company The Channel Company.
Laguna Hills, Calif.-based Corporate Finance Associates is an investment banking firm with decades of experience in executing mergers and acquisitions in the IT and telecom services industries.
Holland said there are two types of buyers: the financial buyer and the strategic buyer.
Strategic buyers typically pay mostly cash at close in their deal structure and there’s typically a small earnout. The seller of the business generally doesn’t retain an interest in the entity, according to Holland.
Financial buyers, or private equity firms, have a platform company and go out and hunt for strategic acquisitions. They then acquire and integrate smaller companies to absorb into that bigger company.
“They’re willing to pay a premium for the platform company because it’s really hard to find a great platform company,” Holland said. “But you need to do your due diligence on the private equity firm and make sure you understand the major executives in that company, the goals of that company, the strategy of that company and the track record of that company. What are they going to do with your business? Make sure your vision and your goals are aligned with that private equity company or else this could be really a path and pain for you.”
This is because the PE firm will most likely turn around and sell the business in three to seven years, sometimes at a much higher price.
“But there’s no guarantee. It’s highly risky,” he said. “Sometimes these things blow up. So if you’re selling a business to a private equity firm, they’re going to tell you a rosy picture about how brilliant they are and how great and how much money you’ll make a few years from now.”
Carlos Diaz, CEO of Great Neck, New York-based Vulcan Business Solutions, told CRN that acquiring a business, and selling his MSP, is part of his game plan down the road.
“It’s overwhelming,” he said. “You have to take the emotional piece out of it. It’s the same thing when you’re selling a home. A lot of people think their home is worth a million dollars but in reality it’s not. It’s the same thing with a business.”
He learned from Holland’s talk that there’s a lot of factors that make up the value of the business and that there’s a lot of things to consider.
“You have to be able to prove it with a report. You can’t go with a gut feeling,” he said. “That’s the thing I realized. There’s a lot of metrics that are in involved in buying or selling.”
Jason Wright, CEO of Houston-based MSP Avatar Computer Solutions, has both bought and sold MSPs in the past.
“I think that the private equity market has gotten a lot smarter about the MSP vertical because they were overpaying for MSPs early on,” he told CRN. “I think they realized how hard they are to grow organically and so now they’ve tightened the requirements. That’s why we’re seeing more scrutiny around deals.”
Below are five things that Holland says MSPs should expect and prepare for when buying, or selling, a business.
Develop A Track Record Of Revenue And Earnings Growth
Acquirers are attracted to businesses because of the growth potential, and sometimes the history of that growth gives confidence in the acquirer.
With many IT service providers in particular, monthly recurring revenues are very important, particularly if they’re under contract. The longer the contract term, the better.
It’s also important to build and retain a strong management team because the acquirer is buying the company and the team that constitutes that company.
“You need to retain your management team and find the best management team,” he said. “And train invested in the management team.”
Employ A Disciplined Sales Pipeline System
“I can tell you when you sell your business, don’t just think about the price that you are selling for. Consider alignment with the acquirer, deal structure, and net working capital,” Holland said.
When getting ready to sell, MSPs must make sure their accounting is reliable and accurate, he said. Whoever oversees the accounting system should, very quickly, at the end of each month, generate financial statements and other reports as the acquirer will want to see them.
“Any delay in providing financial reports raises questions by the buyer,” he said.
It’s also important to curtail non-business expenses, such as travel, meals and entertainment.
“Most business owners have some non-business expenses, it’s perfectly normal, but if you’re getting ready to sell a business, you want to try and clear all that up,” he said. “Stop doing that to the extent. There’s usually going to be some that there, but if it’s egregious, they’ll walk away from a business.”
Don’t Dance With A Pro Until You’ve Mastered The Dance Steps
When selling a business, the relationship between the seller and the acquirer is not symmetrical in any way. The transaction is most likely the first for the seller, but the acquirer has probably acquired dozens of businesses.
“The acquirer typically has a skilled M&A attorney, skilled financial analysts, a skilled M&A CPA and they know what they’re doing. They know how to negotiate a deal,” he said. “So if you step in the ring with a skilled, experienced, sophisticated acquirer, you’re going to get chewed up.”
To prepare, Holland said build a team of expert advisors who can help you including a CPA and an attorney with M&A experience.
Conduct An Objective Analysis Of Valuation
Many business owners have a number in mind that they want to sell their business for. Holland said that number is “completely irrelevant.”
“No one is going to base a valuation on that. So just be objective,” he said. “If you think that your business is worth far less than your dream, then don’t even waste any time talking to that acquirer because it would be completely a waste of time.
He also said to “soul search” to define the ideal and the intolerable outcomes as this may be the most difficult part.
“If you’re selling a business, you need to understand what’s in your heart,” he said. “If you want to just retire and move off, then a strategic buyer is perfect for you. If you’ve still got fire in your belly and you’re passionate for business, then a private equity buyer is the path to go because you can stay involved and grow the business together with a financial partner.”
Prepare A Forecast With An Earnout In Mind
“Whoever acquires the business is going to basically earn out on your forecast,” he said. “If your forecast is unattainable and pie-in-the-sky unrealistic, then the earnout’s going to be based on that and you’re not going to get paid out on the earnout. So that’s the risk there.”
It’s also important to resolve any litigation the business has before going to market.
There are also two ways to go to market, through a proprietary deal or a simultaneous agreement. With a proprietary deal there’s no competition and the seller in most cases lands a great deal.
“They’re not going to pay as much as the market would otherwise demand as they’re relying on the fact that the business owner is not very sophisticated about M&A, so the buyer exploits that,” Holland said.
A simultaneous engagement involves multiple bidders which a seller can play off with each other therefore optimizing the value and deal structure of the transaction.
It’s also important to have a confidentiality agreement and letter of intent.
“The first contract that is signed is a letter of intent, and that is the path forward on the deal with both parties,” he said. “It has some binding clauses and some non-binding clauses. I recommend not rushing into a letter of intent.”