Booming MSP industries bring together the mergers and acquisitions market, which is hotter than ever. Just in 2023, the MSP M&A market has witnessed a growth of 20%. Buyers are now willing to pay premium valuations for businesses that demonstrate scalability, recurring revenue, and operational excellence. So what is it that drives those premium valuations?
We're going to take this blog and dissect the key drivers that buyers are looking for, give real-world examples, and then share some actionable tips that'll help you maximize your MSP's valuation.
1. Recurring Revenue: The 1 Driver of Premium Valuations
Buyers love predictability, and nothing spells predictability like recurring revenue. MSPs with a strong MRR model are much more attractive to buyers than those reliant on one-off projects. Here's why:
- Valuation Multiples: MSPs with more than 80% recurring revenue will normally command valuation multiples of 8-10x EBITDA while those below 50% recurring revenue command multiples of 3-5x.
- Customer Retention: Those businesses with a customer retention rate of 90 percent or higher are said to be low-risk investments. This further drives up their valuation.
Actionable Tip: Focus on building long-term contracts and subscription-based services. If your recurring revenue is below 70%, consider transitioning more clients to MRR models.
2. Scalability: Prove Your Growth Potential
Buyers aren’t just investing in your current business—they’re investing in your future potential. Scalability is a critical factor in determining valuation, and MSPs that demonstrate the ability to grow efficiently are rewarded handsomely.
With automation tools such as RMM and PSA platforms in place, automation-enabled MSPs can support 30-40% more clients with the same team size, which is a major improvement in profitability.
15% or better year-over-year revenue growth indicates that you are also likely to draw higher premium offerings.
Actionable Tip: Invest in scalable technologies and standardize your processes. Document your workflows to ensure they are seamless from onboarding through service delivery as your business grows.
3. Customer Retention: The Hidden Gem of Valuation
High customer retention is not just a sign of a healthy business; it's a direct indicator of long-term profitability. Buyers are willing to pay a premium for MSPs with loyal, satisfied clients.
- Churn Rate Impact: MSPs with a churn rate below 10% can increase their valuation by 15-20% compared to those with higher churn rates.
- NPS: Organisations that have an NPS score of 70 or better are considered to have strong customer relationships, thus being a better organisation to purchase from.
Actionable Advice: Institute customer success programs; keep regularly polling clients about opportunities for growth. Look to lower churn and enhance satisfaction metrics.
4. Operational Excellence: Efficiency = Value
Buyers want to see a well-oiled machine, not a business held together by duct tape. MSPs with documented processes, strong financials, and efficient operations are much more likely to command premium valuations.
- Profit Margins: MSPs with profit margins above 20% are considered highly efficient and often receive higher valuation multiples.
- Employee Productivity: Businesses where each employee generates $150,000 or more in annual revenue are seen as operationally superior.
Actionable Tip: Operational audit to find inefficiencies. Invest in training, tools, and processes that improve productivity and profitability.
5. Diversification: Reduce Risk, Increase Value
Too much reliance on one client, vendor, or service offering is a red flag for buyers. Diversification reduces risk and makes your business more attractive.
- Client Concentration: MSPs with no single client accounting for more than 10% of revenue are considered to be lower-risk investments.
- Service Mix: Businesses that offer a balanced mix of services (for example, 40% managed IT, 30% cybersecurity, 20% cloud services, and 10% consulting) are more resilient and valuable.
Actionable Tip: Diversify your services and avoid dependence on a single client or vendor. Consider adding in-demand services, such as cybersecurity or cloud migration.
One of our client experienced:
1. Recurring Revenue Grew: 80% of their clients transitioned to MRR models. Recurring revenue grew to 85%.
2. Scalability Improved: Investment in automation tools helped them increase the number of clients by 35% while keeping headcounts constant.
3. Increased Customer Retention: Through the introduction of a customer success program, they were able to bring their churn rate down to 8% and boost their NPS to 75.
4. Process Standardization: They were able to write down all the processes and push profit margins to 22%.
Key Mistakes To Avoid
-Single-client exposure: Buyers look at this situation as being unacceptably at risk, depending on revenue share of greater than 20%. Processes Lacking Documentation, Scare or deter Buyers who are sensitive or have apprehensive feelings with up to a potential 10%-15% adverse impact
-Crummy Finances: Non-Level Revenue Stream with Messy accounting and record can reduce a companies valuation multiple in the neighborhood 2x-to-3fold.
Actionable Tip: Address these issues proactively. Diversify your customer base, document your processes, and keep your books clean.
Preparation for the Emotional Aspects of Acquisitions
Selling your MSP is far more than a financial exercise; it is an emotional ride. Buyers have to see that your team and culture will survive but thrive post-acquisition. Here's how to prepare for it:
- Team Alignment: Get your team aligned with the transition. Businesses with good employee retention rates are more attractive to buyers.
- Cultural Fit: Find a buyer who shares your values and vision. Misaligned culture can even derail a promising deal.
Actionable Tip: Openly communicate with your team and include them in the process. This will ease the transition and preserve your business's value.
Leverage the Trends Today
Today, the MSP M&A market is hot and on the rise; premium valuations are reserved for stand-out businesses. Leverage recurring revenue, scalability, customer retention, operational excellence, and diversification to position yourself for a best-in-class price.