Managed service provider valuations are soaring, yet firms are under elevated scrutiny.
The MSP market continues to attract capital from investors a decade after the first wave of private equity firms first capitalized on the space. The field of buyers is now crowded, with smaller companies fetching high premiums from large MSP platforms.
Industry insiders say MSPs are fetching record valuations — even after the COVID-19 boom sent MSP profits skyrocketing. Recurring revenue remains a prized asset for investors, and MSPs are increasingly the route to market for leading OEMs.
“Valuations for good MSPs have never been better,” Peter Kujawa, EVP and general manager of Service Leadership, told Channel Dive.
Emphasis on “good.” Investors are drawing a dividing line between A-tier and B-tier MSPs, Martinwolf managing partner Seth Collins said. A wide chasm exists between the two in terms of multiples they receive.
Buyers have also expanded their checklist for rating an MSP. They’re evaluating customer contracts more closely, parsing out recurring and non-recurring revenue and paying more attention to sales and marketing.
“The due diligence has changed,” said Brian Kane, VP of MSP channels at Malwarebytes. “The level of detail that we go into is significantly more versus, ‘Show me your QuickBooks and what your monthly billings look like.’”
Measuring multiples
The industry average for valuations vary based on the details of the acquisition.
Aventis Advisors, in a study of 120 MSP deals earlier this year, found a median multiple of 8.9 for MSP deals. In middle deal, the acquirer paid the MSP an amount 8.9 times more than the MSP’s EBITDA. The median size of $38.5 million. Smaller businesses often drew a range of five to eight, with the smallest MSPs drawing three to four.
Evergreen Services Group typically pays out six to eight times an MSP’s EBITDA, Evergreen M&A advisor Craig Fulton told Channel Dive. But Fulton noted that Evergreen retains the brands and owners of the companies it acquires and does not intend to flip its investment.
A new era of M&A
MSP purchasers have matured significantly over the last decade.
Kujawa regards 2014 as the year private equity investors truly paid attention to the MSPs. Many of them discovered MSPs after originally investing in SaaS companies. For those investors, MSPs was another recurring revenue-rich market to tap.
Fulton said money flowed more freely in the first wave of MSP investments. Kane said he saw buyers offering MSPs 13 times their EBITDA — more than double what he sees today.
“Back in the day, I saw crazy multiples. Crazy multiples,” Kane said.
But the early bets were full of mistakes and bad strategies, as investors “didn’t know what they were buying,” Kane said. Investors intended to apply the playbooks they used for SaaS, unaware of the significant differences in the models.
“You watch this first wave investment kind of go wrong, because they didn't really understand IT services,” Fulton told Channel Dive. “And then some really solid players started to show up.”
Those players include Evergreen, New Charter Technologies, Thrive Networks, Courser and Integris. Together, they’ve consolidated a major chunk of the MSP market.
Kujawa said Service Leadership in 2014 found that 80% of MSPs were less than $6 million in revenue. That number is now 70%. Service Leadership in 2022 said 69% of MSPs were smaller than $5 million.
Having established their platforms, acquirers are now thinking more about expertise than scale.
"The days of size arbitrage are over,” Collins told Channel Dive in an email. “We're no longer seeing smaller MSPs combine into a larger entity without full integration. This is still happening in other sectors, but buyers are much more savvy in the MSP space, which is more mature, with many roll-ups having successfully traded.”
Marks of value
The investor community has learned that recurring revenue is no longer a virtue in and of itself.
Fulton said buyers are taking a deeper look at managed service contracts, prioritizing those with a longer shelf life. A three-year or five-year contract will be more prized than a one-year agreement, Fulton said. Investors are looking to see if there are termination clauses or stipulations for price increases in the contract. They might not have been doing that three years ago, Fulton said.
Investors care more about risk than ever before, Collins said.
“The ability to demonstrate growth while maintaining or increasing gross margins and EBITDA is a key driver in valuation, as well as in generating recurring revenue, retaining customers, and driving demand,” Collins said. He added that investors value intellectual property, including but not limited to AI-based tools.
