M&A: What does "good fit" really mean?

By David Weeks, VP of Partner Experience at N-able.

  • 1 month ago Posted in

The MSP business model thrives on scale. The good news for MSPs is that the sector continues to grow, with Canalys predicting revenues to increase 12% in 2024. With the greater need for MSPs over the pandemic, followed by economic uncertainty, we might have expected a big rise in revenues followed by a correction—but the reality has been remarkably stable.

One change has been in the number of mergers and acquisitions (M&A). Our research found a 60% decline in M&A activity in 2023 compared to the previous year. While the MSP market continued to grow, the appetite for the risk of acquiring a whole other company did not.

By the end of this year, we’re likely to see this change. But there is a disparity in the market. Also found in the MSP Horizons Report, 44% of MSPs are looking to acquire, but only 13% are actively seeking to sell. Demand is outstripping supply, meaning buyers will have less choice than they might hope. Finding the right MSP to acquire requires careful consideration, making finding the right fit even more difficult.

Why acquire?

Consolidation can be a sign of a maturing market, one where businesses with good recurring revenues have been built and make for tempting targets for acquisition. It can also be a sign of a sector in trouble, as failing businesses with valuable assets are snapped up by competitors who think they can make these work.

For the MSP market, it’s the former—successful MSPs are looking to increase their headcount, acquire new customers and improve their technology, and the easiest way to do this can be to acquire or merge with another business. Despite the growth in the MSP market, many struggle to land new customers—not because of the value they offer—but simply because marketing can be difficult if they don’t have the required funds or staff, and word of mouth and referrals can only scale so far. Recruitment in order to scale is also tough, and buying another MSP increases headcount at a stroke. It also has the potential to bring in new technologies and expertise. If an MSP is failing to provide the level of security its customers demand, it can train up staff and invest in onboarding new technology—or spend money on a security specialist.

Of course, it’s not really that simple. M&A is complicated, from exhaustive due diligence processes to the contractual details. And no one MSP is the same as another. It’s vital to figure out if one being considered is a “good fit”.

What is a good fit?

There is rarely going to be such a thing as a perfect fit. The trick is figuring out if the compromises and pain are worth the rewards. These are the main areas to think about:

 

Technology and expertise: One compelling reason to buy another MSP is to create a larger MSP with a wider portfolio of services, and staff who know how to make the most of this technology. The obvious consideration is where the two MSPs overlap, and where they do not. Will cross-selling be simple? If the MSPs are using competing technologies, will it be possible to migrate customers to one of them? An acquisition or merger needs to be just that to be effective, rather than simply putting two different companies with essentially separate customers under the same name.

 

It’s also worth looking beyond technical expertise. A bigger company will need more effective non-technical departments, for example in sales and marketing. Is the expertise there or will it need to be added? When new business is the biggest problem, creating a bigger business with the same issue isn’t ideal.

 

Customers: One of the most compelling reasons to acquire an MSP is to acquire the customers that come with it. But how closely do these customers resemble the customers of the acquiring business? Again, the idea is to eventually integrate two businesses into one, and while MSPs are able to service a wide range of customers, there is always a certain amount of specialisation. An MSP that, for example, works mainly with small retailers may struggle to meet the needs of a new set of customers that are mainly in petrochemicals. Their needs will be different, and the more different they are, the tougher it will be to integrate these customers under one MSP.

 

Business objectives: If the two MSPs were to continue as separate businesses, what would their plans be? Would they align? Is a fast-growing, ambitious MSP buying one that has a more slow-and-steady approach to growth? When integrating these two businesses, will it be possible to keep that ambition, or will it need to be tempered somewhat? This overlaps with the thorny issue of culture.

 

Timing: Businesses would benefit from keeping in mind the timing of the integration. If integrating the new company lingers on, costs associated with it could start to add up. Costs such as consulting fees, travel, and other expenses relating to the integration process should be considered.

 

Culture: If an M&A deal was to go badly, there’s a good chance that culture will be at the heart of the problem. Due diligence focuses on the finances and prospects of the business, but the same care needs to be taken on potential culture clashes. Some of these are more obvious than others. If it’s an international deal, there will be regulations and cultural expectations around working hours that will differ. These aren’t unsurmountable, but they need to be recognised. There are also more subtle differences that need to be taken into account.

 

Culture is a word that covers many different aspects of a business. One business may have a CEO that is very sales-focused and hands-off when it comes to the technical side of the business, while another may have built the MSP from a small business and retains a close relationship with customers, sometimes getting involved in fixing problems. Neither of these approaches are wrong, but if integration is handled badly there could be problems handling employee and customer expectations.

 

This is important as even minor changes can lead to resentment, and ultimately employee and customer churn, chipping away at the reasons MSPs consider M&A in the first place.

 

All of this is not just relevant for the acquirer, but the business being acquired too. The process of consolidation takes time, and it’s common for the owners of an acquired business to have a stake in the success of the new business. A tempting offer needs to be considered carefully. Owners need to consider if the values and principles they have built in their company will continue—it’s a practical consideration, not mere sentimentalism.

 

There will always be compromises to be made when two businesses consolidate. The key to ensuring a good fit is to consider these ahead of time, and to ensure due diligence goes far beyond the commercial aspects.

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