MSP valuations: Four factors to consider
“How much is my managed services provider business worth?”
Whether it comes from MSPs looking to sell their company in the next few years to business owners who are interested in measuring annual growth with an eye toward selling down the line, this is a question that comes up frequently in IT circles.
Knowing the factors that potential buyers might evaluate in your MSP is important because 1) it gives you an idea of the metrics to optimize to increase your business’s value, and 2) it can prevent you from accepting a sub-optimal offer in the future.
Read on for four key factors that influence MSP valuations, plus tips for getting your business ready to sell.
1. Earnings before interest, taxes, depreciation, and amortization (EBITDA)
How to calculate: Net Income + Interest + Taxes + Depreciation + Amortization = EBITDA
The #1 factor that buyers are interested in is the profitability of your MSP. EBITDA is a commonly used profitability metric because it can be used to compare organizations with different taxes, financial structures, and depreciation policies.
- Annual EBITDA $250k - $1 million: Typically results in a valuation of 4-5x annual EBITDA.
- Annual EBITDA $1 million - $2 million: Typically results in a valuation of 5-6x annual EBITDA.
- Annual EBITDA $2 million - $5 million: Typically results in a valuation of 6-8x annual EBITDA.
In the eyes of buyers, companies with higher EBITDA command higher valuation multiples because they have proved their ability to scale operations while earning (and keeping) customers.
2. Net profit margin
How to calculate: ( Net profit / Total revenue ) x 100 = Net profit margin
Along with EBITDA, net profit margin is a key factor in determining the profitability and valuation of your MSP. Buyers often view high profit margins as an indicator of MSP operational maturity, which can lead to better valuation multiples. For example, if two companies both have $500,000 annual EBITDA but one has a 15% net profit margin and the other has a 10% net profit margin, company A might be valued at 5x EBITDA while company B receives an offer for 4x EBITDA.
According to research from CompTIA, only 30% of MSPs believe that they are doing a good job of maximizing their net profit margins. This number highlights the need for MSPs to increase operational efficiency through automating routine processes, eliminating unnecessary expenses, and optimizing resource utilization across the company.
3. Recurring revenue rate
How to calculate: ( Average revenue per account x Total # of accounts ) = Recurring revenue rate
A good recurring revenue rate proves that an MSP is likely to remain profitable in the future, as it won’t need to rely on net-new sales to keep cash flow running. Building a business that is largely driven by recurring revenue allows you to:
- Maintain a more predictable revenue source and accurately forecast future income.
- Increase customer satisfaction by nurturing long-term relationships based on trust.
- Sell additional products and services to your customers (upselling or cross-selling).
Some buyers will desire (or even require) that an MSP generate at least 50% of its business from recurring revenue to be considered for purchase.
4. Customer retention rate
How to calculate: ( # of customers at the end of X time period – # of new customers gained during X time period) / # of customers at the beginning of X time period = Customer retention rate
Related to recurring revenue, customer retention rate is another factor that’s closely examined during MSP valuations. Buyers often compare an MSP’s customer retention rate across three-, four-, and five-year periods to see whether it’s trending upwards, trending downwards, or remaining flat. According to Invesp, increasing an MSP’s customer retention rate by just 5% can result in profit increases anywhere from 25% all the way up to 95%.
A high level of customer churn (the opposite of customer retention) is a bad omen, as it signals that an MSP isn’t able to maintain long-lasting relationships that contribute to predictable revenue growth. To keep your customer retention rate trending upward, make sure you are steering away from these common missteps that cause customers to leave their MSPs.
Preparing to sell
For MSPs owners who have decided to sell their businesses, there are a few steps that can be taken to make sure all goes according to plan. Here are some things to consider in addition to the metrics mentioned above.
Clean up your finances
This may sound like basic advice, but you’d be surprised how often companies get dinged during MSP valuations due to poor bookkeeping. While it is best practice not to run personal or non-business related finances through your company, you must be able to identify those items and explain why they should be excluded from the financial information.
To keep everything as clean and organized as possible, an MSP billing solution can help streamline your financial workflows, apply billing best practices, and reduce the time spent on repetitive tasks.
Start planning far in advance
A rock-solid MSP exit strategy sometimes takes a couple years to develop — not a couple months. Prospective buyers will want to start conducting their due diligence soon after making contact with your MSP, which means you should prepare well in advance by:
- Cleaning up and organizing client contracts
- Maintaining client contracts in one centralized place
- Cataloging job descriptions for all employees
- Documenting standard operating procedures
- Assembling annual performance reports dating back as far as possible
Do your homework on potential buyers so that you are prepared to answer the questions they might ask on calls or during meetings. Don’t be afraid to shine a light on what makes your MSP unique and why they should be excited about the opportunity to purchase.
Tell your story well
Pitching your MSP business to an interested buyer is an art form, one that goes beyond sending them a file filled with documents and spreadsheets that shows them the monetary value of your business. Your MSP is the culmination of years of hard work: the systems and technology you’ve optimized, the clients you’ve earned, and the employees you’ve attracted and kept on staff.
That’s why you should be ready to tell the full story of your MSP — how it came to be and why you believe it’s primed for more success in the future. If you can effectively articulate this vision to a buyer, it could be the factor that seals the deal on top of impressive on-paper performance.
Increasing the value of your MSP
Whether you’re looking to sell your MSP or take stock of how its value has changed over the years, it’s wise to keep an eye on these key factors for MSP valuations. Ultimately, the goal is to focus on growing EBITDA and net profit margins with an emphasis on increasing recurring revenue streams and customer retention.