With few exceptions, businesses are built on dreams and aspirations. Entrepreneurs often start with an idea or two and a little capital, but through a lot of sweat and ingenuity, they turn it into a viable product or company. Shoestring budgets are the norm, as the business owners look for the most cost-effective methods to accomplish their goals and build the framework needed to grow a successful organization. If all goes well, the entrepreneur will accomplish his goals and create a potential employment opportunity for many others. The time and equity business owners put in at this point is one of the most important investments they will make—but they must also continue to appraise the “value” of the company from this point forward.
That same entrepreneurial process is typically followed by the MSP community. Individual inspiration often comes to those who are employed by other IT professionals, where they learn the basics of the business and discover the endless opportunities available to those with creativity and a tremendous work ethic. While the capital costs may not be as significant as most businesses, launching an MSP organization is no easy task, often requiring a greater investment in time and training (technical and business).
While some assess the capital needs before setting up a new services organization, they often fail to calculate and track the value of the company with any regularity. That makes it difficult to understand where (and when) to make investments that will improve the worth of an MSP business.
M&A Planning for All
During an organization’s first few years of operation, its financial resources and assets are often leveraged to a high extent. Payments for set up and initial services often consume a large part of the company’s revenue at first, though the MSP recurring revenue model offers a faster route to profitability. Owners are often more focused on revenue than value during the initial stages of business growth, but many experts suggest that merger and acquisition potential should also be top of mind.
Not every entrepreneur wants to sell their creation, especially early on in its development, but the practice of valuing the organization prepares them for a number of possibilities. For example, if an MSP needs a credit extension to take on a major new client, are their finances and information in order to do it quickly? Time can be a factor when a prospect wants to move quickly, especially when they have alternate plans or quotes in hand.
Value and equity are closely tied, but managed services clouds that equation a bit. While equipment and cash on hand are important, long-term contracts are often the greatest asset of an MSP organization. Recurring revenue is money in the bank, at least on a financial statement, so the more clients they sign to these agreements, the greater the valuation of the business. Before an MSP organization opens its doors (or sets up a home office), a balance sheet with all these assets and it current liabilities should be in place. But that’s just one of the steps in “valuing” the business.
The Worth of an MSP
In the early days of managed services, one of the great unknowns was the going rate for mergers and acquisition as larger solution providers decided to enter this promising field via that route. Between 2005 and 2010, the value of an MSP business was approximately six times the company’s annual recurring revenue. That figure has dropped substantially since that time, with more recent M&A activity reported as low as .5 (1/2) of a year’s recurring revenue.
Those values are roughly double that of a traditional VAR business and, by focusing on the fundamentals, many MSPs continue to receive a substantial return on their investment. Through careful analysis, the management team can improve many financial metrics in the business, including profitability and total revenue.
No matter how large an MSP’s sales, if the organization is bleeding red or yields a margin below the industry average, its value to others (including lenders) will be lower than healthier companies. Profitability is critical measure of a managed services business, even when times are tough, and it goes hand-in-hand with revenue growth. But that’s often a tough balance, especially when investments are needed to expand into new markets or create additional service practices.
Increase Value by Leveraging Relationships
How does an MSP build it sales and portfolio without a significant negative effect on its financials? A strategic growth plan that includes partnering options is essential to attaining that goal. Through relationships with vendors, distributors and other outsource companies, MSPs can create a number of options to expand their business.
For example, rather than building a healthcare IT practice from scratch to take advantage of a market opportunity, it may be more cost-effective to forge a partnership with a new vendor or another IT professional. A mutually beneficial relationship will reduce (or eliminate) the need for capital by either party, and should increase each party’s revenue. Through partnerships, profit margins can be preserved and the organizations’ value should be elevated.
The same situation plays out with helpdesk services. Hiring and managing a call center can be costly for an emerging MSP, especially in areas where skilled professionals are hard to find (and retain). By partnering with hosted help desk companies it removes both the complexity and cost of building a new helpdesk, and offers access to a number of other high-level technical resources. Partnering not only makes good financial sense, but typically increases customer service levels and often leads to additional projects with current clients. That means more revenue for the MSP and a greater overall value to their business.