M&A Expert: We’re Seeing ‘Larger Buyers Swim Downmarket’

‘You’re seeing a lot of larger buyers swim downmarket for the smaller businesses because of resources, because they still want to grow a certain percentage of revenue each year. And so we’re still seeing a lot of activity in the smaller midmarket space,’ says Tim Mueller, president of M&A advisory firm martinwolf.

Inflation and interest rates have dampened acquisition interest in larger solution providers that bring in more than $50 million in revenue and have hundreds of employees, but buyers are still interested in deals for smaller midmarket services businesses.

That’s according to Tim Mueller, president of Scottsdale, Ariz.-based M&A advisory firm martinwolf, who spoke to attendees as part of CRN parent The Channel Company’s XChange NexGen 2022 conference in Orlando, Fla.

“I don‘t want to make the suggestion that the smaller midmarket deals are recession-proof because literally nothing is totally recession-proof,” Mueller said this week. “But you’re seeing a lot of larger buyers swim downmarket for the smaller businesses because of resources, because they still want to grow a certain percentage of revenue each year. And so we’re still seeing a lot of activity in the smaller midmarket space.”

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Brent Yax, CEO of Troy, Mich.-based Awecomm, attended Mueller’s talk to learn more about the multiples IT companies are selling for and how buyers categorize acquisition targets, he told CRN in an interview.

Yax said he has been thinking about whether he should acquire a business to further boost Awecomm’s offerings.

“It’s always good to know where we fall,” Yax said.

MSPs have seen recent multiples between 6.5 and 10 times adjusted earnings before interest, taxes, depreciation and amortization (EBITDA), Mueller said.

HIs firm’s median transaction value over the last five years is $40 million and the mean is more than $100 million, he said.

Traditional IT partners and systems integrators have been fetching between 5.25 and 7.5 times adjusted EBITDA, he said.

“Those who are still squarely in that eat-what-you-kill space of traditional IT services are getting taken advantage of, if you will, by the buyers because they don‘t want businesses that have a lot of projects that have sunsets that are spaced out throughout the year,” Mueller said. “They want that recurring revenue and signed contracts.”

Recurring revenue, Mueller said, means a year-plus-long contract is signed with a customer, not that a customer has been with a partner for a long time.

Software-as-a-Service companies see multiples of 2 to 6 times revenue. And MSSPs have seen multiples of 1 to 3 times revenue due to the amount they invest in infrastructure and new employees, Mueller said.

“The ability to start pivoting toward offering the cybersecurity side of it will make you much more valuable as providers,” he said.

Buyers want MSPs investing in artificial intelligence, cloud, mobile, video and security technology, Mueller said.

“As far as I‘m concerned, AI, if you’re not using it or planning to use it, you’re behind,” he said.

Buyers look for about 90 percent client net dollar retention. They also want to see revenue come from a mix of customers, not just a handful. And they want gross margins of around 50 percent excluding hardware resales.

And for those businesses that employ a mix of business models, buyers will apply a blended valuation.

MSPs are attractive acquisition targets because companies are still seeking ways to decrease capital expenditures—decreasing the amount of IT assets they actually own—and IT remains too complex for them to handle on their own. Customers also are having trouble hiring IT workers or looking to avoid having a higher head count, he said.

“We’ve never seen it before, partially because the KPMGs and Accentures didn‘t want to do all the due diligence required to buy a small business like you just to move the needle a little bit with revenue,” Mueller said, using the consulting giants as examples. “But because of the resources, they’re willing to start doing that.”

For those interested in selling, Mueller warned that buyers are offering less money at deal close and trying to stretch out the rest of the purchase price over a series of years, with executives staying on and meeting aggressive growth targets.

Mueller said that even if a business is considering selling, it still needs to invest in ERP and other costs of running the business to keep up customer service and employee morale.

“On the other hand, run the business like you’re going to sell it because at that point you’re keeping an eye on the numbers that matter. So if you hit those each year, then when you’re looking one, two, three years [back] from a buyer’s perspective, everything kind of lines up,” he said.