Navigating MSP M&A: Capital, Growth, & Strategies for Success in a Shifting Market w/ Abraham Garver

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[00:00:52] Dave Sobel here again at IT Nation Connect with another bonus episode of the Business of Technology.

[00:00:57] Tech here with Abraham Garver of Focus Investment Banking. Great to have you back.

[00:01:03] It's awesome to be back.

[00:01:04] So I want to start kind of dive right in a little bit because I want to get a sense of what's going on in terms of the M&A market

[00:01:12] because it feels like there's a bit of tension going on right now in terms of the, that is shifting the money around a little bit for a little bit more in sellers' favor.

[00:01:22] Tell me a little bit about the conditions on the ground.

[00:01:25] Yeah. So there's just a lot of capital.

[00:01:28] There are a lot of private equity groups that really want to make an investment in an MSP.

[00:01:34] And they have either they kind of found out about it, you know, a couple of years into the cycle or they've been trying for an extended period.

[00:01:43] So we have, let's see, at my firm we have 106 private equity groups in line for, to make an MSP platform investment.

[00:01:54] And that platform typically will see the MSP has operational maturity where it's at least 3 million of EBITDA.

[00:02:03] But of that 106, call it 45, are looking for 15 million of EBITDA or more.

[00:02:11] Okay.

[00:02:11] So we've really had a big, you know, kind of the bigger funds have come in and they're looking for bigger assets.

[00:02:19] Okay. So to be fair, there aren't nearly that many of those, right?

[00:02:23] So if we think about it and kind of, it's a weird hourglass funnel, right?

[00:02:27] So there's some big players out there that have already been funded and already have launched.

[00:02:31] Yeah.

[00:02:32] There's a large number of smaller players, well below the numbers that you're talking about.

[00:02:36] Like 3 million in EBITDA is a sizable business.

[00:02:39] That's a sizable business.

[00:02:41] And we know, you know, with 87% of this market doing roughly $10 million or less of revenue.

[00:02:47] Yes.

[00:02:48] There's a lot out there.

[00:02:49] Now this is intriguing to me because that also leaves an interesting dearth in that middle.

[00:02:54] Talk to me about what we're seeing in terms of this.

[00:02:57] You're looking at the smaller ones, like kind of what's going on, what's missing.

[00:03:01] What are the smaller ones not able to offer yet that's investment ready?

[00:03:09] You know, at that size, there is just a lack of operational maturity.

[00:03:14] And by that, one of the key things I see is they're not able to add new logos.

[00:03:20] Okay.

[00:03:20] Kind of consistent rate.

[00:03:22] Or they may be, it may be owner-led sales only.

[00:03:27] And that owner-led sales, you know, kind of 3 million of revenue has been a hard inflection point to get over for one owner.

[00:03:35] And they're also kind of running the business.

[00:03:37] And what's really valuable to investors, because likely that owner is going to exit.

[00:03:44] And if they've been the only one generating kind of new logos, new customers, if you buy their business, you're buying their customers essentially, and not an ability to keep, you know, keep adding new customers.

[00:03:58] Okay.

[00:03:59] So, you know, a lot of these listeners are going to be thinking about, well, okay, if I'm starting to think about my planning, about what I want to do with the asset that is my business.

[00:04:08] And they're probably on that smaller side based on just the raw numbers.

[00:04:13] If they were calling you up and saying like, hey, how do I get there?

[00:04:17] What would be some of the advice that you're directing them on?

[00:04:19] So my mind immediately goes to join a peer group.

[00:04:24] Okay.

[00:04:25] There are multiple peer groups out there.

[00:04:27] There's IT Nation Evolve.

[00:04:29] There is True Methods.

[00:04:32] There is a couple others, too, that have been, you know, just incredibly helpful to that MSP so that they don't have to figure everything out on their own right out of the gate.

[00:04:44] Gotcha.

[00:04:45] Okay.

[00:04:45] I think it's just, you know, you're working against time.

[00:04:49] Time is not your friend.

[00:04:50] And the more you can leverage what one of your peers in a different market has done, that can really help, you know, accelerate your path to become more valuable.

[00:05:01] Gotcha.

[00:05:01] Now, I want to switch to the other side of the market.

[00:05:03] Talk a little bit about the buyers because, you know, a lot of capital seeking investment.

[00:05:08] But I know that they're not all necessarily thinking with the same thesis, right?

[00:05:12] Because they're looking for different.

[00:05:14] But give me a little bit of sense.

[00:05:15] I suspect you can put them probably into a couple of buckets.

[00:05:18] Give me a little bit of a sense of the different investment theses that are out there.

[00:05:22] Just to give listeners a sense of what that looks like.

[00:05:25] So, when we're first contacted by a private equity group and they've, you know, they're crafting a thesis or they just built a thesis, they're going to say, we want to be in a regulated industry.

[00:05:38] We want to be in financial, as an example, financial services, healthcare, you know, the CMMC portion of manufacturing.

[00:05:48] And what they don't realize is everybody that's come before them also started out with exactly that identical thesis and already really consolidated that, you know, that market.

[00:06:01] And so, I think for buyers, it's incumbent on them to find a niche.

[00:06:10] And I kind of always say, like, my tagline is like, one of my taglines is riches and niches.

[00:06:16] And it's incumbent on not only the MSA to find a niche to help it get new logos, but it's incumbent on that investor to be willing to find a niche that nobody else is in.

[00:06:29] And because all your other peers have been trying to invest in MSPs, you know, kind of in the second generation back to 2020.

[00:06:40] You know, so we're multiple years in now at this point.

[00:06:43] And it's, you know, I think you have to think different to be successful.

[00:06:47] Now, my audience knows that I always encourage people to not lean too much into tech stack as a differentiator.

[00:06:53] But I feel like it would be important to understand when an investor and a buyer is looking at this, how much is tech stack part of their decision-making process?

[00:07:03] If you're in, if your kind of platform is on one, you know, kind of, let's say, ConnectWise or the Kaseya or Enable, if it starts out on one of those, it can be helpful to continue to have other targets.

[00:07:19] I think if, you know, I asked Kevin Blake one time of TechMD, Kevin, will you, and he's on the ConnectWise platform, like, can I bring you targets that are Kaseya or kind of, why are you at the Kaseya conference?

[00:07:33] He's like, it doesn't matter.

[00:07:35] You know, I don't need to be on that platform.

[00:07:39] So I think it's definitely more tricky to get from an integration perspective.

[00:07:48] But, you know, it's not a deal killer one way or the other.

[00:07:52] Gotcha.

[00:07:53] Now, the other thing I wanted to get a sense of is, and again, not necessarily looking at any particular number or moment, but I want to get a sense of, like, how much and which economic trends influence these deals.

[00:08:05] Is it just interest rates?

[00:08:07] Is it GDP growth, job growth, something I didn't name?

[00:08:12] Tell me a little bit of, like, which of those factors are important to keep an eye on and how they influence a deal.

[00:08:17] Three come to mind.

[00:08:18] The first is our, you know, our mutual friend, Peter Kajawa, pointed out at one of the sessions here that prior to an election every four years, there is a, you know, kind of decrease in associated spending and revenue for MSPs.

[00:08:33] And then it bounces back up.

[00:08:36] That was neat that he pulled that out of data.

[00:08:39] Two, interest rates you would think would have some sort of an impact.

[00:08:44] What we've really seen is they have not.

[00:08:46] Because they're 106 waiting.

[00:08:50] They have funds that they raise that for 10 years, they'll, you know, they're investing for 10 years.

[00:08:55] They can't get the money back.

[00:08:57] It's not, you know, capital has not been an issue.

[00:09:02] And as a result, any other trend that you throw out there, like, you know, hurricanes can have a, you know, as an example, can have an impact in a specific geography.

[00:09:13] But there are no other macro events that we've seen, including the pandemic, that, you know, really tanked the MSP business.

[00:09:25] It continues to grow at about 10%.

[00:09:28] Whereas, you know, overall kind of GDP growth across the world, more in the 2% range.

[00:09:35] So we have one of the best industries kind of, you know, available and an incredible tail leg.

[00:09:41] Yeah.

[00:09:42] You mentioned Peter.

[00:09:43] He and I talked on the show as well.

[00:09:45] And what he brought up, that interesting data about the presidential election, and what he also brought up was some data around a little bit of slowing organic growth.

[00:09:53] Now, his message was that, like, it's been slowing.

[00:09:56] It's not catastrophic.

[00:09:57] You also have seen some stuff around organic growth.

[00:10:00] Tell me a little bit of what you're seeing related to organic growth.

[00:10:03] Yeah.

[00:10:04] I mean, I would say, like, I'm a reporter.

[00:10:06] I am going to report what I'm seeing on the front line of these with all these buyers and the assets.

[00:10:14] And what I'm seeing on the front line is just extreme interest in business, in MSPs that can add new logos.

[00:10:22] Okay.

[00:10:22] And do it without, you know, just the owner.

[00:10:25] So when the owner leaves it.

[00:10:27] So extreme interest.

[00:10:29] And if we think about it, you know, in finance, like if somebody buys a bond and it's got a coupon, that's a lot like an MSP.

[00:10:39] Because of the recurring revenue, we're going to get a coupon.

[00:10:42] We're going to get MRR every month.

[00:10:45] Right.

[00:10:45] And we care about what's the retention of that coupon and MRR.

[00:10:50] Will it still be there three years from now, four years from now?

[00:10:55] But even more important than that stream of buying existing customers, my bond is, or this business that I'm buying is so incredibly valuable.

[00:11:06] If in addition to those coupons at the retention rate, I can start adding new bonds, like a new, you know, here's another new logo, another new logo.

[00:11:16] And one of the platforms we worked on that closed at the beginning of the year added 33 new logos last year.

[00:11:23] So even if they have a face plant this year, they're going to add probably 25 new logos.

[00:11:30] And that makes that so much more valuable than doing M&A, where you buy a business and integrate it and kind of it's non-recurring.

[00:11:41] It's going to happen one time.

[00:11:42] It may not happen again.

[00:11:44] Gotcha.

[00:11:45] Now, the other thing you mentioned that I kind of wanted to ask about is you're talking about sort of second generation investing groups here.

[00:11:51] We're also seeing some of the first generation do second rounds, trade off, second business.

[00:11:56] And what I kind of wanted to get your sense of is one of the things that I talked to a lot of the investors and I often talk about what their thesis is and what they talk about.

[00:12:05] And they've been talking recently more about this idea of talking about day one, that a lot of the sellers are understanding what day one post sale looks like.

[00:12:14] Yeah.

[00:12:15] And what I'd like to get from you is a little bit of sense for you, from your, you've done a bunch of these deals, you've been involved with a watch.

[00:12:20] What are the things that are happening on day one of a deal and the conditions that are met that are proving to be more successful beyond?

[00:12:29] Because many of these owners are trying to get a second bite of the apple, do it again.

[00:12:32] What are the conditions for that day one that seem to be most successful?

[00:12:35] I love, I mean, I love this question because, and this is what I'm, I am so passionate about this.

[00:12:42] I think of it as act one is the founder CEO, act two is the first institutional money.

[00:12:49] And act three is that recapitalization.

[00:12:51] We're going to get a larger private equity group bid.

[00:12:54] So as I act one, I'm leaving act one.

[00:12:58] Those were kind of a lot of these MSPs in 2020 and 2021, the first institutional money coming in.

[00:13:04] And some of those we did merger of equal, using that as a term of art.

[00:13:09] I think it's really, really fun to, in when, when we're going now from act two to act three, to take an asset that, for instance, it's really good with M&A and integration, but it's, and it's terrible with organic growth.

[00:13:27] I like to come to the new act three buyer with half of the business.

[00:13:33] Seven million of EBITDA is an MSP standalone that is just focused on M&A and integration.

[00:13:39] And then I come to it with an $8 million that's fully integrated.

[00:13:44] That's got a great organic growth rate, 15%.

[00:13:47] It's got a strong management team.

[00:13:49] So I'm going to deliver what the buyer wants, 15 of EBITDA.

[00:13:53] And that 15 of EBITDA meets their needs.

[00:13:56] It's less expensive for that act three buyer because they've, they're paying less because that seven gear is worth less without the organic growth.

[00:14:05] And it's phenomenal because to your question, what do I do on day one?

[00:14:10] My, I feel like our role, my role is to, similar to like construction.

[00:14:16] Somebody's going to build a, um, a building, you know, a corporate building.

[00:14:21] I want that act three buyer to show up on day one and have a really nice operating A to B EBITDA, um, great organic growth, great management team.

[00:14:32] I want to give them something that they're going to need.

[00:14:34] It's a project they're going to need to work on.

[00:14:36] And I want them to have access to the project and not have to start, go out starting from scratch.

[00:14:43] So I want to bring all the building blocks.

[00:14:46] So there's those two key assets.

[00:14:48] And then I'm also going to add, we're also going to add an M&A pipeline and have side letters of intent.

[00:14:54] So in day, um, day 30, day 60, day 90, we bring in more assets that help with organic growth.

[00:15:03] And so that's like, I think that's, I don't think many people do that.

[00:15:08] And that's really, as the market's matured, that's our point of differentiation is we're not going to run an auction on the seven or the eight and hand it over to somebody on day one.

[00:15:19] And they go, what do we do now?

[00:15:21] Like we want to help them be ready for day one.

[00:15:25] I love insights when you sort of say something, not a lot of people are doing something because that's always an area to highlight.

[00:15:30] I want to ask like a really broad directional question, because I like that we're exploring this idea of act threes and act fours.

[00:15:37] How far does that go?

[00:15:39] Because, and the reason I asked this is it feels like there's a cooling of the IPO market and it feels like directionally organizations across industries are not targeting the IPO as like the end state.

[00:15:51] Are we looking at this at a market that may just trade, we'll get into act 20, act 30, act 40, and it just keeps going back and forth.

[00:15:58] Do you think organizations as this goes out, and I know I'm asking you to project really far out, but I kind of directionally like to get your sense.

[00:16:06] Where does it go?

[00:16:08] So there are what are called like permanent capital private equity groups.

[00:16:13] Some of the largest asset managers in the world that we have had as buy side clients seeking 25 million of EBITDA or more that they will buy design.

[00:16:23] They want to hold on to it and they want to be a seller in five, six years.

[00:16:29] So they're different.

[00:16:30] Yeah, it does kind of, you know, we're getting some big ones.

[00:16:33] We're getting some 60 of EBITDA, 70.

[00:16:35] We have, you know, Evergreen hit 100 plus.

[00:16:37] You have New Charter 40, Integris 40.

[00:16:41] Right.

[00:16:41] Where might they go?

[00:16:43] And they keep, yeah, they keep going to the next larger, like Plama Bravo is among the largest.

[00:16:49] And so you think about like their size of their investment and, and ConnectWise and this, you know, this business.

[00:16:56] So there's still a way to go.

[00:16:57] I mean, ConnectWise, you know, I think is a earlier the year, this year before acquisitions had 250 million of EBITDA.

[00:17:04] Yeah.

[00:17:05] So we still have a way to go.

[00:17:06] But we want, we also want to keep, we want to keep software providers out of the MSP, particularly for listeners because different.

[00:17:13] And I would be remiss if I didn't observe you throughout Tama Bravo, who are often unpopular with some MSPs.

[00:17:19] But it's important for the listeners to separate that the software side investment is very different than the services side.

[00:17:26] And that's an awesome point because like as these private equity groups come to us, they want exposure to MSP.

[00:17:33] They don't want any, anything else attached to your MSP.

[00:17:37] Like a lot of people over time will come to us and say, Hey, I'm thinking of getting into this business because it's, it'd be, it's a concentric circle away from MSP.

[00:17:47] I'm like, well, I think that's fine if you don't want to sell it, but the buyer is going to want exposure just to MSP.

[00:17:55] Interesting.

[00:17:55] And that's by the way, a detailed point that I wanted to highlight, particularly for those MSPs that are thinking about spinning off a product.

[00:18:01] That's a strategy.

[00:18:02] It is a set of choices that may make impact later.

[00:18:06] Right.

[00:18:06] That's very difficult, especially the smaller sizes.

[00:18:09] It's like, yeah.

[00:18:11] Well, Abram, I always love so much having you on.

[00:18:13] This has been great fun.

[00:18:15] I'm looking forward to talking to you again in the new year.

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