5 Tips For Attracting Private Equity Investment In Your MSP

"From a valuation perspective, I’d love to say there’s an algorithm where you can put in some data, then all of a sudden it spits out a valuation. That’s really not the case."

How Private Equity Views An MSP's Valuation

Assessing the valuation of a managed service provider is an artform, not a science, and some unique metrics can come into play, said Trey Sykes, managing principal at private equity Inverness Graham.

“From a valuation perspective, I’d love to say there’s an algorithm where you can put in some data, then all of a sudden it spits out a valuation. That’s really not the case,” said Sykes during an executive session at XChange 2019. “It’s buyers and sellers, and it’s the perception of value that any one MSP might have at any one point in time. I look at valuation as more of an art than a science. There are some things that create a fundamental basis for a good valuation of a company.”

Sykes has 20 years of experience as a buyout principal and board member of various solution providers. He is responsible for managing Newtown Square, Pa.-based Inverness Graham’s portfolio of companies, investment banking relations and investing efforts for the firm.

Here are five key tips from Sykes for MSPs hoping to attract investments from private equity firms.

Recurring Revenue Is Crucial

Recurring revenue services growth as well as the percentage of total revenue that is recurring are crucial measures for valuation, according to Sykes. Having a greater portion of a business come from recurring revenue compared to simply product resale is more important now than ever.

"The thing that I’ve known about recurring revenue is as I’m building a company and I have a strategy around building a company, that recurring revenue allows me the time to build and invest in the company, compared to thinking about constantly every year trying to get my revenue up with brand new customers every single year," Sykes said.

Phil Jaderborg, the owner and CEO of PJ Networks Computer Services, Charlottesville, Va., said his top takeaway from the session was to keep monthly recurring revenue as his No. 1 priority.

Currently, PJ Networks does $1 million a year in business with $600,000 of that in recurring revenue, said Jaderborg. “My takeaway is to start looking at our numbers harder and create a story or CIM (Confidential Information Memorandum) that you can tell to a potential buyer,” he said.

Jaderborg said he would like to sell his business in the next five years with the goal of increasing his monthly recurring revenue to $1.5 million or about 85 percent of total sales. “Five years ago, we almost had no monthly recurring revenue,” he said. “Then we decided to become an MSP rather than doing break/fix. Now we do managed monitoring, managed security, updates and backups. Most of our clients are buying an all-in corporate edge service.”

EBITA Is More Important Than Revenue

Depending on the industry, a company’s valuation can be derived from various types of revenue figures. In the MSP market, Earnings Before Interest Taxes and Amortization (EBITA) is seen as a more import than total revenue for a solution provider.

“In this industry, the most predominate use of valuation metrics would be EBITA multiples, not revenue multiples,” said Sykes. “So I have $10 million in revenue and multiply that by two-times, so $20 million is the valuation. Or some industries you have EBITA as a valuation. I have $1 million in EBITA, multiply that times nine, so $9 million is your evaluation.”

EBITA measures a company’s operational profitability by including equipment costs and excluding financing costs.

Scale Is One OF Most Important Metrics

An MSP's ability to successfully scale year after year plays a big role in private equity firms' decision making. Simply put, “size means a lot,” said Sykes.

“There are certain things in terms of size, where people reach a level and it’s hard to break beyond that,” said Sykes. “For principal-led organizations – it’s hard to break and scale in that principal-led organization beyond a certain point. Scale becomes much more important from a valuation standpoint.”

Inverness Graham is taking a number of companies in its portfolio and putting them together in a strategic fashion to build scale. “If you have $20 million in revenue, you’re pretty big in terms of scale,” he said.

Having One Person Do Everything Can Hurt Valuation

If the leader of an MSP hasn’t delegated much of the responsibility for running the business, it can hurt valuation. Sykes agreed with David Powell, Chief Revenue Officer at Corsica Technologies – which was acquired by Inverness Graham last year – that a company’s valuation can be lowered if one person plays too big a role inside an MSP.

“How much of your success is based on you being part of the business? Because if you are the one that is doing all the things, then it’s very difficult to go and sell that to someone else,” said Powell. “I get it, as a principal, you’re still going to have your fingers in lots of different pots of the company, but have you hired competent people to sit in key seats to diminish the impact that you need to have in all those different parts of the business?”

Sykes said private equity can view too much leadership from a single person as bad for valuation.

Proprietary Selling Process Much Faster Than Investment Bank

When an MSP is ready to sell into a private equity firm there are two primary ways to process the sale. An MSP can take the more traditional route of going through an investment bank, which Sykes says takes a seven- to twelve-month time frame before completion of the sale. The other way is through a proprietary process without an investment bank.

“With a proprietary process, I get an opportunity to have more of a one-on-one relationship with a company, and it offers speed to close: speed to close for the selling and speed to close for the buyer,” said Sykes. “If I meet with somebody and I can agree to a valuation within that week, I can get that transaction done in 20 to 30 days. … I think speed to close is actually really, really critical.”

He said there are some advantages with an investment bank process. “Maybe you don’t have the right fit as a buyer or as a seller that fits your model and where you want to go with a company,” Sykes said. “So this way gives a view of different kind of sellers.”