Acquiring a Managed Service Provider Business. Part I: Reasons, Targets and Due Diligence
Even though analysts report that the MSP acquisition market has slowed down, the topic is still hot, and many MSPs start considering acquisitions once they reach a certain size.
In this series of articles, we will examine the aspects of acquisition that may be useful for MSPs considering their first acquisition and IT professionals considering starting an MSP by acquiring an existing business.
Why acquire an MSP?
There may be multiple reasons for acquiring an existing operational MSP business besides growing the customer base. While getting more customers and more technicians to serve those customers is often named as a primary reason, there are other benefits to consider while working on the acquisition.
New services and expertise in the portfolio
Bringing people with new expertise to offer additional services allows MSPs to upsell additional services to their customer base. Diversifying the portfolio also provides for acquiring new customers who demand new services. The most popular services added via acquisitions are security, disaster recovery and virtual CIO services.
New location
Most MSPs serve customers within a reasonable driving range, limiting the business's growth to the technician's ability to be on-site within a day. Additional locations expand the geographical presence and potential customer base.
Cost savings at scale
More business enables MSPs to negotiate better deals with hardware and software vendors, get additional incentives through distributors, and save on operational costs like finance and legal fees.
Reduction of marketing costs by eliminating competition in the local market
Not having a competitor nearby going after your customer base reduces marketing costs and acquiring a smaller but more aggressive competitor can be a way to eliminate the competitive pressure.
Identifying acquisition targets
Once the acquisition objectives are defined, it becomes straightforward to look for a match. The best practice is to build a table with the search criteria and conduct market research, populating the table with the information needed to make the decisions.
The usual parameters to consider:
- Size of the company – employees and customers, revenue and margin (if available)
- Service offering – complimentary offerings, unique expertise
- Technology stack – complementary or completely different, consolidated or diverse
- Industry focus – critical in case of solid focus on vertical marketing
- Contract terms – monthly, annual, multi-year
- Pricing structure – lower or higher, flexible or fixed
- Reputation – social media, reviews, customer interviews can be helpful
- Management team and team culture – is it the founder-led company or the company led by the professional management
- Partnerships – vendors and distributors used by the company
After collecting the information, it is time to contact the owners and discuss the opportunity. Given that many MSPs are “lifestyle businesses” and rarely valued highly, rejection of communication about the acquisition opportunity is usual and should not discourage you from looking at other targets.
Tip: Many MSPs value their relationships with their employees—as they become a family over the years—and at the beginning of the conversations, it is important to have a solid vision for what is going to happen with the team and look for a cultural fit with the existing team.
Due diligence process
The acquisition process requires legal and financial support, and the best practice is to retain people with experience driving acquisitions. However, the future owner should delve very deeply into the details of due diligence before making the final decision on whether to finalize the deal, what price to offer or whether to walk away from the deal and look somewhere else. There are multiple areas for due diligence for any sizable business.
Financial
Review current and past financial statements and dynamics. Look for discrepancies in the reporting and revenue recognition practices. A change of ownership may force some customers who are on the verge of moving to another MSP to decide to proceed now. Review debts and leases and terms for them.
Legal
Review contracts with existing customers and terms of termination. Look for liabilities and protections in place, especially in downtime and cyber incidents. Review insurance agreements and coverage. Investigate any opportunities for litigation and check for the status and impact of any past litigation. If there is proprietary technology in place—acquired or developed in-hours—investigate the intellectual property rights. Be diligent in reviewing compliance with regulations, depending on the industries served.
Technical
Assess the technology stack and IT infrastructure in place. Look at the cost of operating and upgrading the infrastructure. Review documentation, especially the documentation for customer onboarding, offboarding and daily maintenance. Weak documentation and relying on employee knowledge are red flags.
Be diligent about software licenses and compliance with vendor licensing policies. Quite often, you may discover unlicensed software, and in some cases, even counterfeit software, that will become your problem after the acquisition.
Put particular emphasis on evaluating cybersecurity, including the technology used, procedures to maintain cybersecurity, level of knowledge, and presence of incident response policies.
Team
Besides reviewing contracts and HR policies, it is crucial to interview employees and understand team dynamics well. There is a chance that the relationships with the management retain employees, and after the acquisition, you may face resignations or have to incur significant expenses for the retention bonuses.
Look for the key employees and informal leaders on the team and evaluate if they are a cultural match for you and your team and if you can work with them.
The business of MSP is purely people; thus, evaluating the team is the top priority for the leader, and external consultants are rarely able to do it for the leaders.
In the next article, we will look at the approach to the valuation and execution of the transaction.