For many channel pros, the route to increased growth is through acquiring another MSP. That said, the M&A process is complex and requires careful due diligence before closing a deal.
As attractive as buying another company may be, it’s wise to be pragmatic.
Understand Common M&A Risks
Mergers and acquisitions are risky. Before jumping into the process, know that it’s a time-consuming endeavor that can distract you from running your business.
This means any hands-on duties you normally assume need to be delegated to someone else, pointed out Mahen Gundecha, a partner with Boise, ID-based exit planning and M&A advisory firm Bristol Group.
Post-acquisition, merging two organizations is a complex process. The MSP buyer must shift into an operational leader who assigns key responsibilities to others in the merged company — sometimes to individuals from the seller’s organization that they don’t know well.
Mahen Gundecha
“You may have to rely on people from that company to serve in critical leadership roles,” Gundecha said. “Are you willing to take that leap of faith?”
The merging entities also need to integrate their technology stacks. For example, the buyer may be a ConnectWise shop, while the seller is running Kaseya. In this scenario, you must determine how long each entity will run on parallel systems before onboarding everything onto one or the other.
Complications in Blending the ‘Family’
The merging of two MSPs may present both clients and employees with a good excuse to leave. This has a direct impact on the profit and loss (P&L) statement.
“If you lose key customers [and] key employees, guess what? You’ve just overpaid for that company,” Gundecha noted.
Employee retention is a major concern when the two organizations offer different salary and benefits packages. The seller may have better healthcare, for example. Will everyone be upgraded to this plan? If so, the acquiring MSP likely will incur higher healthcare costs.
Both customer and employee retention at the seller’s organization may be reliant, in part, on the presence of the selling founder. In this case, that individual should stay with the merged company for as long as possible, Gundecha advised. This can be tricky, though. People who are accustomed to being the boss aren’t always amenable to assuming the role of employee.
“The [selling] founder has to be willing to operate within the new culture, and be willing to be open and transparent, and not have a hidden agenda with his team or with his customers,” Gundecha said.
Read the Fine Print
Customer contracts pose another risk to acquiring MSPs. For example, the firm being bought may not have disclaimers in its service-level agreements (SLAs) that protect the MSP from liability in the event of, for instance, service outages.
“The last thing you want is for a client to be able to make a claim for lost profits because its system went down,” said Christal Contini, chair of the M&A practice at Cleveland-based law firm McDonald Hopkins LLC.
Rather, customer contracts should include disclaimers that prevent this from happening. “Some smaller MSPs might not have all of those terms and conditions to the standard that you need to protect the company on a go-forward basis.”
There also may be discrepancies between what the seller charges customers versus the buyer’s established rates.
“It’s really hard to suddenly buy that book of business and on Day 1 say, ‘I need to charge you $40 more per hour,’” illustrated John Ahlberg, CEO and founder of Chicago-based Waident Technology Solutions, a SOC 2 MSP that has bought several MSPs. Increasing rates for these customers should be a gradual process.
Christal Contini
“And you need to be comfortable with [the fact that] as we increase our rates, some of these people are just going to fall off because they’re not going to want to pay,” he added.
Financing an Acquisition
Another key aspect of a successful acquisition is determining how to finance the deal effectively. The way you fund your acquisition can significantly affect the merger’s overall success of the merger, as it influences both your cash flow and your negotiating power with sellers.
In Gundecha’s experience, smaller buyers will often finance an acquisition through a 50% cash purchase, and then an earn-out or note paid out over three to five years. Some will secure a bank or an SBA loan.
However, the M&A landscape is competitive and attracts well-financed buyers, Gundecha said. Getting a loan through the SBA can take time, and a 50% cash deal isn’t as appealing to sellers when there is another potential buyer that’s willing to pay 80%.
“As soon as you have a company that’s generating half-a-million dollars in profit or EBITDA, you get the bigger strategic buyers stepping in,” he said. These entities pay more in cash and close the deal faster.
Ensuring You Got What You Bought
In M&A transactions, a seller will make representations and warranties about its business that cover things like:
- Who its customers are
- What the employee benefit plans look like
- That it’s complying with the law
- What its insurance contracts include
The buyer, in turn, relies on these representations and warranties to make sure that it is getting what it signed up for. The problem is, sometimes sellers misrepresent their businesses. In this case, usually the buyer may seek recourse against the seller, Contini explained.
“The legal terms of an acquisition of another MSP are very important because the buyer needs to ensure it’s getting what it thinks it’s getting, but also that it’s not taking on liabilities that it doesn’t want to take on,” Contini said.
Know Your Own Organization
John Ahlberg
Before acquiring another MSP, it’s necessary for owners to have a detailed understanding of how their own company operates. A buyer must thoroughly understand its own P&L statement. For example:
- What services are driving your profit margins?
- What services are less profitable?
- Do you have enough staff?
- Do you have too many people on your team?
“We sometimes get into situations where one MSP generating $3 million in revenue could be operating with 15 staff, and another is working with 30. Why?” Gundecha noted. “Understand your strengths and weaknesses. Do a SWOT [strengths, weaknesses, opportunities and threats] analysis of your own company first.”
It’s also important to know your willingness to take chances. “Inherently, it turns into risk focus for the business owner because there are a ton of risks,” Ahlberg said.
Instead of viewing risk as something negative, Ahlberg embraces it so that he can work through it.
“It’s easier the second and third time, but that first time can be a big leap. You have to be OK with it on your end.”
Is M&A Really the Best Growth Strategy?
Before jumping onto the M&A train, MSP owners need to decide if it’s the right growth strategy for them. Some other potential paths to increase business performance can include:
- Expanding offerings to your existing customer base
- Offering new services, such as cybersecurity
- Developing business in a new vertical market
Source: Mahen Gundecha of Bristol Group Business Brokers
Image: DALL-E
