Welcome back to RKCA’s IT MSP newsletter. This time we are going to look at what we consider “Best in Breed” for a number of the metrics many IT MSP owners collect on their business. We have also included a snapshot of the transactions that took place through Q3’24 for the industry(1).
What Makes a “Best in Breed” IT MSP?
We often see business owners use metrics and different key performance indicators (“KPIs”) to try and make informed decisions about how to run their company. They don’t often understand what numbers they should be working towards, just that these numbers should be “better” in some way. Below we’ve targeted a number of key metrics that we see come up often in transactions, but will help any business owner looking to build a “Best in Breed” IT MSP.
Revenue Composition: This KPI is a breakdown of the various revenue streams in an IT MSP. At the most basic level, a company’s revenue can be broken down between recurring and non-recurring revenue categories. These categories can be broken down further into additional segments. While all revenue is important to a buyer, it is not all created equal. Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) which can be attributed to recurring revenue is going to get valued at a higher multiple compared to EBITDA coming from one-time project or product revenue. We often consider “Best in Breed” IT MSPs to have a recurring revenue above 75% of the total revenue figure.
Revenue Growth: Revenue growth is often a double-edged sword when it comes to preparing for a transaction. Many owners may not want to sell if the business is experiencing strong growth, feeling they are leaving money on the table. However, in our experience buyers often do not pay the premium multiples seen in the space for a business that is stagnant or experiencing low levels of growth. Because of this, RKCA often sees businesses with consistent revenue growth of over 15% year-over-year as “Best in Breed” for the IT MSP space.
Revenue Retention: Some teams focus on signing long-term contracts with each and every client, but if there are 30-day outs in those contracts, they are essentially month-to-month. That is why RKCA views revenue retention as a highly important metric for IT MSPs. There are two kinds of revenue retention, gross and net. Gross revenue compares all revenue in the current period to all revenue in the prior period. Net revenue retention only includes revenue from the current period from customers that had revenue in the previous period, to all the revenue in the previous period. By way of example if an IT MSP has one customer in year one with sales of $10,000,000, and then in year two it has two customers with sales of $9,000,0000 and $1,000,0000 respectively, gross revenue retention is 100% but net revenue retention is only 90%. We feel that to be considered a “Best in Breed” IT MSP your net revenue retention should be above 95%.
EBITDA Margin: We believe EBITDA is critical to the valuation achieved in an M&A transaction. We see that sellers often overlook how that number correlates to their total revenue number outside of the assumption that more revenue correlates to more EBITDA. While this is directionally correct, it’s important to understand how much of this is proportionally dropping to the bottom line and buyers know this. In our view, a top tier IT MSP will see a fully burdened EBITDA margin in excess of 22%.
Top Three Client Concentration:
Having big clients is often desirable for any business, particularly for a business that’s still growing to maturity. That said, a company that is too reliant on one or a few customers can be seen by a buyer as problematic, and could affect valuation in a transaction. Keeping client concentration to a minimum is important and IT MSPs that RKCA sees as “Best in Breed” have their top three clients making up less than 30% of their revenue.
“Best in Breed” Cultures:
What we have outlined above are the quantitative measures of what we consider “Best in Breed” IT MSPs based upon today’s standards. However, there are qualitative factors that make an IT MSP attractive for a buyer. We recently had a chance to catch up with Bill Tyndall, Founder and CEO of Tynrose, and a Founding Executive at Electric AI about what he considers to make an MSP “Best in Breed.”
Based upon the dozens of acquisitions targets that he has reviewed over the last several years, his perspective was insightful and noted “math is math” when it comes to the metrics, but Bill focuses on culture. “I call them hammers versus nails. It’s the businesses and the business leaders that are driving impact and driving thought leadership on how services should be delivered and how services should be experienced.” He explained that when business leaders are focused on their service delivery and how they are providing that service, it relates to ands leads to higher retention, higher average spend per user, and all the metrics that are deemed to be top class. He went on to explain that some issues above, including customer concentration, scale, and client profitability can be solved by growth. Other aspects around the team are “rooted in the infrastructure and foundation of what the business really is.” In his mind, culture is the hardest piece to solve when determining if an IT MSP is truly “Best in Breed.”
(1) Transactions tracked via ChannelE2E.com, Corporate Finance Associates, and Channel Futures as of September 30, 2024
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Recent Transactions
