Why We Need to be Thinking Smart About M&A

Over the past few years, we’ve been seeing large-scale consolidation taking place in our marketplace, with private equity firms and margin-based companies, such as telcos and traditional IT consulting businesses, investing heavily in MSPs.

The key factors driving this growing interest are predominantly centred around the changing IT landscape for businesses. These include increased security challenges in the mid-market, as well as increased technical challenges with more and more businesses moving to the cloud. On top of this, businesses are also finding they need to support a growing range of devices. Plus, of course, there’s the move to working from home (WFH), which has sparked additional technical requirements as companies seek to secure and manage their dramatically expanding perimeters.

This is the world in which MSPs have been living for some time—helping businesses to manage exactly these issues—and generally they’ve been doing a good job there. But not only are they doing a good job technically, they are also doing a good job from a business perspective, having learned to create recurring revenue for their services. With many organizations struggling to recruit, retain, and maintain qualified staff to keep up with all the changes taking place from a technology perspective, private equity firms and adjacent businesses like VARs and telcos are seeing MSPs as a way to provide an effective and, possibly even more importantly, lucrative way for them to help businesses bridge this gap.

This has become such a key focus that through my own manual tracking I’m currently seeing around 13 M&A deals a month in the MSP category, with over 200 private equity firms focused on investing here. Broadly, these acquisitions tend to fall into one of three different flavors:

1. Private equity funded shell companies

Here a shell company will buy multiple MSPs but keep them as independently functioning organisations. By keeping these companies independent they keep the management team intact and allow them to run the business as they wish. This serves to minimize any market and employee disruption that can come from an M&A. From here, they can start to slowly integrate collaborative concepts across the group. For example, they might start to collaborate on marketing, or HR, or legal. This way, integrating this businesses is a slower process rather than a dramatic change.

The downside of this setup is that the acquiring company is not really maximizing on a lot of efficiencies that they could achieve with a true standardization strategy.

2. Private equity firms buying a platform company

Here the PE firm buys a medium-sized MSP, which goes out and buys other MSPs and tucks them in under their existing brand—forcing the acquired companies, as I like to say, to “change their T-shirts”.

Again, there are pros and cons here. On the plus side, the businesses are forced to consolidate, which allows them to hopefully benefit from increased ROI, for example where they can do more with less. This is the standardization piece I mentioned above. However, there is a potential downside because if they don’t do the integration well, they can see both employee and market disruption.

3. Self-funded acquisitions

We’re starting to see companies like VARs and telcos using their own money to buy into the MSP sector because they really like the recurring revenue that those businesses represent. And there are nice complements to be had here. For example, a consulting firm that has a security specialty and an MSP that has aspirations of doing more in security, but lack the capabilities and know-how, represents a powerful marriage for both sides.

This has been going on for a while now, and while these represent the ideal models, we’ve also seen a lot of scenarios where things have gone wrong. Around five or six years ago, private equity got wind of all the good stuff that was happening in the MSP market and they went on a buying spree. While they were investing a lot of money into the market, they weren’t really thinking through the post-purchase process. So we do have many incidents out there where things didn’t go as planned because there was no standardization strategy in place. These businesses often ended up with multiple different platforms—like RMMs and backup solutions—being used. This led to huge operational challenges, massive inefficiencies, and ultimately big staff turnover, leaving companies stuck with a mess that’s really difficult to undo.

This is not a trend that is going to go away quickly, so it’s important that both MSPs and those looking to buy into this market understand how to get the best out of their M&A activity. So, over the next few blogs, I’m going to explore some of the key things we’ve learned from the market activity and look at how both parties can learn to think smart about M&As. I’m going to look at why standardization is critical and the benefits it can bring to the newly merged business, as well as the role of automaton in gaining operational efficiencies and how newly merged MSPs can get the support they need to continue to scale and grow.

Davide Di Labio is senior director of sales at N‑able