The investment space is on fire for managed services businesses. From mergers and acquisitions to venture capital, profitable MSPs are making major headlines around their financial activity. The managed services model is attractive for external investment because of the power of its rich recurring revenue stream. Today’s steady revenues can serve as a predictor of potential future revenues and collateral to secure capital.
The top performing MSPs are capitalizing on external capital to scale their operation and expand into new services and territories, but many MSPs could be missing out on opportunities to accelerate their growth.
Here are three tips that may reframe your thinking around using external capital to boost your MSP’s growth rate.
1. Reframe your perspective around capital
Most MSPs only think of external capital in terms of an exit event. This is certainly the case for some transactions, but many MSPs are using external funding to grow their business more quickly than they could on their own. This growth could come from adding services, expanding into new markets, or even through the purchase of another business.
Additionally, MSPs treat capital as a four-letter word, and this shouldn’t be the case. External capital is a tool that can be used to help rapidly accelerate business growth. This acceleration doesn’t happen accidentally so, to realize the upside, MSPs must have a clear plan to put cash to work to grow the business.
2. Adopt the right business model
The MSPs getting funded and acquired have built their businesses around proactive managed services. This model is much less volatile than relying on reactive break/fix services.
These MSPs have optimized each portion of the land, expand, and retain equation. They’re able to land customers at a reasonable cost. Once they have a customer, they’re able to demonstrate their value, deepen the relationship, and add services. The added services offer the dual benefit of increasing monthly revenue and raising the barrier to exit for clients.
This model yields predictable recurring revenue. As a result, high-performing MSPs can more accurately model labor costs and future revenues. These revenues can be leveraged to secure external capital.
3. Understand your capital options
For external capital, there are two basic models. You can borrow money from traditional financial institutions, like banks. Alternatively, you can give up equity in your business in exchange for investment.
If you’re considering taking on debt, you should target a level of debt that sufficiently funds business growth while also remaining manageable for your business from a repayment perspective. From a timing perspective, plan to target a repayment period of five to six years.
If you’re considering finding an investor, it’s important to ensure objectives of the investor align with the objectives of your business. You should understand the length of time the investor plans to hold your asset. You should also understand how the investor plans to exit; a range of options includes selling the business to another party, taking the company public, or dividend recap.
The best option will vary based on your personal objectives for your business and the amount of control you wish to retain after the transaction. With both vehicles, you should have a clear understanding of what the partner brings to the table. All cash is not created equal. Some partners will offer just financing, while others will bring expertise and contacts that can accelerate your path to meeting your financial objectives.
As with any transaction, you should plan on vetting and comparing multiple options before choosing a partner. Additionally, plan on conferring with the right mix of advisors, like legal counsel and external or internal CFO, to ensure your interests are well-represented at the negotiating table.
John Pagliuca is president of SolarWinds MSP