Scaling Successfully: WINNING M&A Strategies for MSPs

Good afternoon, everybody. Thank you for joining me today. My name is Carrie Richardson, and I the host of WIN. What's Important Now? Today I'm asking that question to Christopher Vollmand- Carstens, who is the M& A director for NTIVA. How are you doing today, CVC?

I'm doing great. Thanks. Thanks for having me, Carrie. I know it's been a little while since we last chatted, but I'm excited to be back on with you and hopefully it won't be too long before I get to spend some time with both you and Ian together.

So we're going to talk about a topic that is, of course, near and dear to your heart and near and dear to the entire channel's heart lately: we're going to talk about mergers and acquisitions in the MSP space, specifically about how MSPs can prepare their businesses to be attractive to companies like NTIVA, which we've all nicknamed empire builders at this point. So let's talk a little bit about how you got that nickname and why we describe it like that. What's an empire builder?

I think the way to think about it most clearly is we're a business that has spent a majority of our history growing by typical means, organic growth referrals and the like. Then in 2016, Stephen Friedkin, our founder and CEO of NTIVA, took the decision to bring in some outside capital. In the form of investment in our business to really help to scale and grow much more rapidly our organization. And so from that point in time, after making investments in leadership team as well as building out our sales and marketing practice more substantially we also embarked on an aggressive M and a strategy, giving us an opportunity to grow not just in the region, which we are founded in the D. C. Area, but expand into new markets and geographies throughout the U. S. And it's that last piece that M and a angle that has really been probably the crux of why certain folks refer to us as empire builders or"scaled" MSPs. Over the last seven years, we've been fortunate enough to acquire 15 businesses and expand our geographic presence. Across now upwards of 10 markets throughout the U. S. So that accelerated growth through acquisition is probably where that term comes from. But the way we see it is that even though we are growing quite aggressively via acquisition, there are some core tenets to that strategy that help guide us through that journey, and it all gets around to our desire to quote"win" at NTIVA and an all encompassing view to that for not just ourselves, but all the stakeholders and ecosystem around our organization. So I'm happy to talk a little bit more about that. Whether you're calling ourselves an empire builder or a scaled MSP, it is not an uncommon strategy in the market. There's a lot of interest in attraction to the MSP sphere and individuals to want to invest and be part of, the growth and opportunities. So I think, it's an increasingly common place to be to see multiple parties out there looking to do acquisitions throughout the US and even globally.

As a managed service provider looking to exit, you've got a lot of options. What are the key factors that make NTIVA an attractive partner for an MSP looking to exit?

I think it really centers around how we define winning at NTIVA. And in doing so, it also starts to bring up several important questions that a prospective seller, an MSP owner should be contemplating as I think about a transition for their business, because ultimately, every business will transition at some point in time. The preference is to do it while you are vertical. As opposed to horizontal. So if you can be intentional in that journey and find the partner that is best suited for, your hopes, dreams, wishes for yourself, whether it's financially, culturally, your people, your clients that will ultimately give you the best outcome. NTIVA could be an attractive home or an interesting home for a prospective seller. It does come down to three key attributes. The first for us is we are Building a legacy defining brand. And it's defined by long term legacy presence in our community, building our business in the right way, where we are characterized by strong client and employee retention throughout our our existence. It also comes down to our core values of care, ownership, responsiveness, and excellence. But our underlying mission is that we exist to grow each other. Whether that's our people or our clients and technology just happens to be the accelerator as we do so. Yes, we are in technology. This is a technology business, but the people are at the core. And that is ultimately where we can hope to be successful or ultimately, if done poorly, and that's where our failure comes from. The second piece for us for winning an NTIVA is we want to be the most attractive choice. And what that means to us is we want to set what we sometimes refer to as the gold standard, being the best place, the most attractive home for talent, clients, vendors, investors, heck, even competitors or those who want to join join the story and sell into selling to our organization. And then the third piece is we want to create extraordinary financial results. And that's, that's better than ordinary results returns for everyone involved with NTIVA. It's not just our shareholders. It is all our stakeholders, whether it's our employees, our vendors individuals in the community, everyone that is, somehow tied into the ecosystem of NTIVA. We want to see Fantastic outcomes for those individuals. So that's really the three pieces of NTIVA that we define as winning. And if you as you're thinking about evaluating your business and you see some commonality around our mission and values to what you aspire and espouse within your organization, if the other elements that I touched on are exciting and intriguing opportunities for you, then you know, then perhaps NTIVA is the great place to come join forces.

Not everybody will be a suitable acquisition target for NTIVA. Let's talk a little bit about the basics. What are the"must haves" in order for NTIVA to even entertain having a conversation about potentially acquiring your MSP?

Before getting into those, I think an important question to ask as a seller is what it is that you would like to do through the course of this transition or transaction of your business. Do you know what you want to do after the transaction occurs? Whether that's within the business that has acquired you like NTIVA, or do you leave? Do you seek to transition out? Get onto your next adventure, sit poolside or on your boat? Just have that kind of clarity of goal in mind before you go into it. That can be really helpful because there are a tremendous number of options available to you from a buying opportunity. You really want to be able to hone in on those types of buyers that best fit your goals and expectations and aspirations through the transition of your business. Those who will see the most value in you and your organization becoming part of their larger business. So if you can hone in on that's That's incredibly helpful. I think the other thing to get back to your original question Carrie as I divert along here is what is the piece that's most interesting for us from an acquisition perspective? You're wanting to build a legacy together in the right way with the people first culture that's incredibly important. If you are aligned there, that's a Critical first step. Second for us is wanting a business that also serves the small and medium sized business community. Maybe it tails up a little bit into the mid market but that sort of alignment among the customer base and client base is incredibly important for us. Third area is around geographic. Presence and where you're located. We're fortunate enough to be in 10 markets currently throughout the U. S. predominantly in the Midwest in over into the East Coast. And so we're looking for businesses, not just in our existing markets to help grow and establish a majority presence, but also opportunities to expand into new geographies, new markets for us here in the U. S. So there is a bit of a divergence between what is required of those businesses, whether it's coming into an existing market for us or a new market. For us, the desire is really to be a million dollar plus EBITDA business if you're in one of our existing markets. And if you're moving into or are located in what would potentially be a new market for us, there's a higher threshold around 2 to 3 million in in EBITDA for those businesses, but that's, just a baseline financial criteria for us. We can go into a whole host of other attributes on the business around majority recurring revenue, 60 to 70 percent, plus high degrees of operational maturity. A very diversified client mix, meaning that there's not any substantial client concentration among your base, a strong employee retention, strong, 10 percent plus preferred organic growth, great leadership in place, constructive contract terms constructive pricing terms with your clients. The list can go on and on. And it's really about trying to find the appropriate mix of those attributes to put together what a picture or profile of a business would be. I think it's also worth mentioning that, from a geographic perspective, our existing markets, have recently doubled given the recently announced acquisition of The Purple Guys and so in addition to being, in. The D. C. Area, New York, Chicago as well as Colorado. We've now have expanded presence into Louisiana, a couple of markets in Texas, Kansas City area, Indiana, Missouri. So those areas now qualify as our in market locations. But we're looking to, expand not just in those areas, but also into new markets throughout the U. S. Those seem like the wish list, the checklist of things that NTIVA considers before they determine how they're going to value a potential acquisition. There has to be a minimum amount of EBITDA, depending on geography, and you're also going to look at distribution of clients, amount of recurring revenue compared to total revenue.

There was a long list there. They'll be in the show notes for anybody who's listening and wants to make that list. What are some of the things that would be red flags to you, even if the company had that, 1 million to 3 million in EBITDA, what are the things that would dissuade NTIVA from considering a potential acquisition?

Yeah, I think the first run straight out the gate from a red flag perspective is a cultural misalignment between the two businesses. I know that can be hard to quantify in any formulaic way or spreadsheet type of way, but it's one of those things where you get a sense of the vibe of the leader. And do you think that individual and subsequently that organization could fit in well with how we go about our business on the day to day? And so that's an incredibly important first criteria. As an example, if I'm having a conversation for the first time with a CEO of an M. S. P. and that individual is talking about the importance of earnings, revenue, dollars into their pocket above, Absolutely everything else and seems to give short shrift to their clients or their employees and their growth and development opportunities. That's going to be a big red flag for me. And I won't even go down the route of trying to understand. The financial picture or the client picture of that business, because I know that that individual and likely also, that business is just not going to be the right fit for NTIVA.

So if a company is not quite at that, the magic number and they're interested in leaving the MSP space for whatever reason now, family, health, divorce, one of the many reasons that people end up having to sell before they are ready or want to, let's say they've got a 12 month window to start fixing things and they know that within 12 months, they're going to have to sell the company. What should they focus on 1st? Where can they actually make a big enough impact to move the needle enough to create a better valuation for exit?

I think 12 months, gives some period of time to make improvements on the business, but not in an expansive amount of time to make all the changes that you would like to make. It really boils down to where you can make that big impact. And I think as the question outlines that individual wants to transition out of the business. So I think it's about making sure that the business itself is ready and capable of carrying forward after that person leaves, so that you've got a strong leadership and management team in place that owns client relationships, that can handle escalation, that can continue to grow organically without the owner or the leader having to be in every little thing within the organization to keep things running. That ability to transition is a key facet of assessing a business during a potential transaction. So that would be one of the big things that I would focus in on. I think what's also important is being able to drive new client opportunities, new client growth. So I think that's an important thing to, to focus in on during that period of time. And the other thing that I would touch on, and I think they're related, is being able to hold on to and keep not just the clients that you've got on your roster, but also your employees, because if a business is experiencing high degrees of client churn or high degrees of employee attrition, those are going to be some red flags that may pop up during an evaluation process, particularly if you're trying to make a clean exit from the business. You want to try to do some things where you could have more immediate impact and drive more near term results in the business. If you had a longer period of time, call it 24 months or even longer to think about from a transition perspective, continue to work on these things that I just mentioned under the shorter time horizon, but then also work on things like improving the contract terms with which you have your agreements with clients. So there you've got favorable terms in place. You're also working on things like trying to improve pricing or margin performance for your business over time, that does take a period of time to put into place before that can really start to see returns. Then I would just continue to, reinforce that the transition is the plan for you and for the business so that your team, your leaders, your rank and file employees are ready for that sort of transition to take place. The last thing you want to have happen is for there to be a big surprise, which ultimately can lead to disruption, which could, in worst cases, lead to departures from key staff. So keep people apprised of where your head is at. As a leader. I think that's important. You don't necessarily need to say, I'm in active dialogue with a prospective buyer immediately, but to let them know, and they should understand this to a reasonable degree, that you're not going to be the leader forever and ever. Having that shift in mentality can help to future proof the business so that you're getting to that successful outcome.

So you're preparing your team well in advance for the idea that one day you're not going to be at the helm of the business.

Yeah, that's correct.

We looked at a 12 month horizon, 24 month horizon. How long does a transaction normally take?

It depends on when you start the clock Carrie, but from the very first conversation, getting to know an individual, a leader of a business, it can be upwards actually of two to three years before we're ultimately closing on the transaction. Now, during that early period of time, it's not about trying to vet out every single number on the P and L or, assess the precise terms within the contract. It's more about trying to get to know that individual. Establish rapport, trust and learn about that individual and see if that individual and organization is gonna be the right fit for the organization or fit for NTIVA. At that early stage of time, the facets of the business may not be quite the right fit for NTIVA and that there are things that the company needs to work on, and that can take, a year or two or three to work on to really put in place, whether it's, the books and records are clean in the monthly closing. The financials are super easy and efficient or any of the things that we had just mentioned previously to get those things in order. And as you're talking monthly or quarterly or seeing each other at conferences. You're building that relationship between the two sides such that as that selling organization improves its various metrics. Obviously, you're you have the opportunity to push more dollars to the bottom line as you're going month to month, but then also put yourself in a more attractive position as a selling entity. And particularly in the eyes of a buyer like NTIVA. So sometimes it can be upwards of that 2 to 3 year time horizon from that very first conversation to a deal getting done. But once the conversation starts to get real serious about a transaction, the pace starts to quicken significantly. So it can be a matter of weeks. Or, just a few quick months as you're starting to hammer out more precise terms around a letter of intent. And then, once that letter of intent is in place, we really tried to undertake a transaction within, 60 to 90 days from that point in time until close. The pace may be slow to start and then it'll quicken as you get towards the finish line. But if you think about it from overall end to end it can be that longer time horizon. And it's really about just trying to ensure that this business is the right fit for NTIVA.

Are you giving them a honey do list or a checklist of some kind saying hey, we're interested, we like you, we would consider this, but you're not quite where we need you to be. Go work on these five things and let's talk again in six months."

Yeah, absolutely. We've consolidated that into a bit of a, evaluation consultation almost where we can take a look at where the business is currently and look through a whole range of attributes to see where they stand currently and where that valuation could look like for the business at present. And in many cases, You know that does not meet the goals or aspirations of that seller. And then it's about working on the plan to figure out how do you get from point A to point B, where you're not just a more profitable organization, but also more attractive organization and one that could very likely also receive, higher multiple on the performance of the business.

Let's talk about those higher multiples. What are the things that would encourage NTIVA to offer a higher than average multiple to a company?

Yeah. Size is a key contributing factor. Once you get above 500 K or 1, 000, 000 in EBITDA or two or five or 10 typically you're seeing in the market, those multiples do go up. The operational maturity of the business, the leadership presence and management capability of the business is tremendously important. I think the other thing that's worth mentioning, it's become particularly prevalent over the last year or two is a demonstration of skill or expertise within an industry vertical, a specialization, whether it's health care or finance or nonprofits or government contractors or something that can Demonstrate that you've got a differentiated skill set when it comes to a particular industry, vertical or verticals. I think it's what's become common is that clients are demanding more and more from their providers. And they don't want to just be speaking with, Joe on the team who happens to be a bit of a generalist and can talk about and help sort out business challenges, regardless of industry. What we're interested in is. And what those clients are looking for is if they want to speak to Mike, but Mike has got a highly attuned skill set in order to help and solve challenges for regulated financial companies. And so that becomes a much more worthwhile engagement for that client and much more willing to, spend the dollars required to, continue to receive the managed services, but then also know that when issues do arise that. In this example, Mike is very attuned to the needs and particulars of the finance industry. In this example, it can help solve those questions and solve those issues much more rapidly than, Joe in the earlier example Stronger need for clients to want that improved expertise. And so if you've got that as a demonstrated capability in one or two or a handful of industry verticals, that can be seen in the plus category for for a prospective MSP looking to sell.

I know we're beating this one to death, but let's define what operational maturity means for a managed services business owner. Not everyone knows the parameters.

It can cover a variety of different attributes, but I put it to down to You've got a clear organization and managerial structure in the business with reporting lines established, clear goals and expectations and responsibilities for the individuals within the organization within their roles. You've also got clear and repeatable reporting that happens on the monthly basis. From financial P and L perspective, but then also more frequent KPIs and other measurement attributes with respect to service desk performance or project delivery capabilities or other attributes of the business that you're looking to measure performance on. I think it's all also about establishing capabilities for an opportunities for growth and development of the staff and team within the organization. And also, frankly, just an acknowledgement that the owner of the business is not someone that needs to step into 15 different things within the organization to get things to resolution, that there is a highly capable leadership team or management Individuals in place that can solve things without the owner having to be in the weeds within the organization.

How much is having a independently operating sales organization valued when you're looking at an acquisition?

Tremendously important and valuable. If you've got an organic sales engine in place that's tremendously attractive because if you've got that demonstrated growth on your own and it's not beholden to a single individual or a single owner, it gives you just a great deal more flexibility in what you'd like to do with the organization when it does transition. I think providing yourself with more options is really what you're trying to strive towards.

One of the things that we've been seeing a lot of is an MSP will have one great year. They made 35 points in EBITDA and now they're going to sell. But that's the only year that they've ever managed to move the needle that much. Will that 1 outlier year help them enough to move that valuation up?

From our perspective, we're looking across multiple years of performance of the business, the last three years or so preferably to really understand the trends within the organization. Look, it's certainly the case where you'd have a very strong year in your most recent year. Maybe you had a. A large client that just started or a big project that got done or a big hardware software order that got done to help favorable pricing that help skew positively the performance of the business. By the same token, you could have a material client departing. They could have an adverse impact on the business. We're trying to understand kind of the overall picture or story of the organization and don't look exclusively at just the last year to say, ah, just because you did the last 12 months, it was a standout year. Now we're going to apply a very attractive multiple to the business just on the basis of that. Because. When we're acquiring a business, the hope or expectation is that the positive performance that we've seen in the past will be that which can continue in the go forward. And if it's just a one time event, how certain are we that's actually going to be the case? Particularly as we learn more about the circumstances of that one off year of significant benefit, how sustainable could that be? Or would that not be? So that's gonna factor into the story as well.

What's good growth look like year over year? What are you looking for?

I think a good benchmark for growth organically is 10 plus percent organic growth for the business. That's a combination of new logos, new clients coming in the door as well as continuing to expand the capabilities offerings spend from your existing clients. I think that's really where you're going to see material value generated for your business. If you can keep it at that level while at the same time ensuring that you've got very limited attrition for your existing client base, that is also tremendously important It could be a business where you're say you're growing 20 percent organically with new logo coming on board every week or every month. But by the same token, you've got Clients that are, leaving off the back and leaving you. That's not a great story to to sell off of you want to bring in new clients while lose while losing the minimum number of clients.

So you're not looking for a a boat with a hole in the bottom of it.

That's correct. Yeah, that's exactly right.

So what do you see as a buyer when somebody comes to you with extraordinary margins, above average? What are your first thoughts when you're looking at that?

Yeah, I'm thinking about, margins. I guess I'll particularly think around, EBITDA or earning margin if that's at an excessively high level. I'll go back to thinking about industry benchmarking that's out there from service leadership or others in the industry that talk about, You know that around 20 percent EBITDA margin as being close to that best in class top quartile performance of a business, particularly as you start to scale and grow in organization. And so if I see very high EBITDA margins, 35%, 40%. Something along those lines. It starts to ask questions around what is driving that high degree of profitability. Is there sufficient labor and individuals within the organization to really serve the needs of the business now, but also, into the go forward? Are those individuals being paid appropriately for the work that's being done. Are there any sweetheart deals with clients that are allowing for very aggressive pricing to be put in place? Frankly, there may be, very acceptable answers to all of these questions to allow a very high performance of the business. But until I've got an understanding of what those reasons and justifications may be. I'm going to lean in on some of my questions to really round out the story just in light of, what I understand to be best in class performance for a business that is ready, not just for the now, but also for the, the go forward success of the organization.

Let's say they had three years of 40 percent EBITDA. Margins that they were able to hold their growth trajectory is all right Are you going to value them at that 40 percent or do you value them at the amount that you're going to be able to support that business at?

It's probably going to be somewhere in the middle, but probably closer down towards that call it 20 percent normalized level because in analyzing the business i'm going to likely see areas in which Investment may be needed, whether it's account management or V. C. I. O. or other capabilities that will be needed in order to sustain that performance within the NTIVA model. NTIVA Doesn't need to be the only home for an organization as much as it pains me to say that. I think the great thing about the MSP industry is that there are a variety of different paths that you can take when you seek to transition your business and ultimately it's about finding that right home for you. Maybe you want to run it still somewhat independently after a transition by affording you the chance to take some chips off the table, or you do want to fully integrate. Or there are other characteristics that are important to you, or there's cultural alignment, or there's cultural alignment that isn't there. All these sorts of things come into play to allow a seller to find hopefully the right buyer for them. I think that's a great attribute to our industry that may not exist in others where you've got that flexibility to be able to take advantage of that. So there is not just one single path that you have to take when you're looking to transition the company.

What I heard today is it can take up to 3 years for a transaction to happen, especially if you aren't quite where you need to be. There are some things that you can work on in a 3 year period that will take you from where you are now and potentially a valuation that, Would not be acceptable for you or for the generational wealth that you're hoping to create for your family. You can invest three years of hard work in some very specific things And ideally have the valuation that you want at the end.

that's exactly right And I think what's also, worth mentioning is that in order to know Where you're at currently it's helpful to talk with someone who is in the market evaluating Companies day in and day out to Help you prioritize those things that can help to drive the needle change, change the valuation outlook on the business in that timeframe. You've got a finite amount of time in, in your day to be able to focus in on things. And so you really want to spend that time on that, which is going to drive the most positive impact for yourself. And then, it's the personal element, the people element to this business, being able to evaluate that as well. And I think that is not something that happens overnight. This is not a shotgun Hollywood wedding. This is something that should take time to establish and develop. And that's ultimately where you're going to be able to find the highest likelihood of long term success as you come together. If you've vetted out all those sorts of things, you've gone through the quote dating process. for a little while before you ultimately get engaged at the LOI and then get married when the deal gets done.

What else can you leave the listeners with today, Chris? What are you seeing in the market? What are interesting trends? What are the next five years going to look like in the M& A space for us?

I don't know if I can be a prognosticator for the next five years. But what I can say, and I don't think this would be shocking to say, is that the level of attention and interest that is out there within within M& A in our MSP industry is probably at its highest level that I have seen. And so I would encourage listeners to take advantage of every opportunity they can to get themselves smart, smarter, educated on how M& A and how to smartly manage it for your business. If you can take advantage of those opportunities, I think that's where you put yourself at a better position because it gives you insights to know what is working or what it may not be working within your organization. So you can work to improve the business appropriately. But then also when it comes time to transition your business, you're just that much more confident in the decision making that you're ultimately undertaking. Whether this education effort comes through, attending conferences or listening to webinars or seminars, or, relying on peer groups or, other, stakeholders and advisors for yourself, lean into others within the industry who may have a piece of information or knowledge that that you don't have at the current time. I think that's one of the great things about our industry that there is a level of collaboration that can be very constructive So take advantage of it. Folks are happy to talk about it, share, help you learn just as much as they seek to learn. And so I think if you want to put yourself in the best positions, get yourself out there to go ahead and learn something new.

I think that's about all the questions I have for you today, Chris. Thanks for joining us.

Absolutely. Thank you for having me, Carrie.

Thanks very much. Thanks for being on WIN!