What is an MSP?
A managed service provider (MSP) delivers services, such as network, application, infrastructure, and security, via ongoing and regular support and active administration on customers’ premises, in their MSP’s data centre (hosting), or in a third-party data centre.
Why are MSPs such a popular investment target?
MSPs are attractive due to their strong recurring revenues and attractive cash flows. Often, they will also boast diverse customer bases which limit the impact a sector-specific downturn might otherwise have. Additionally, it remains a largely fragmented market primed for a buy-and-build journey, with the possibility of increasing organic growth through a strong cross-selling capability.
Over the past 12 months, we’ve seen an increasing number of MSP businesses coming to the market, and this trend is set to continue in 2023. Through our numerous IT Due Diligence assessments, we have identified some areas that are more susceptible to risk, that every investor looking to invest in an MSP should consider.
Let’s take a closer look.
1. What is the state of the Target’s team resourcing?
Skill scarcity and the highly competitive labour market are resulting in retention issues across the whole technology sector, but this appears particularly acute amongst MSPs, with service desks and technical staff such as network engineers particularly affected.
A staff turnover of ~30% isn’t unusual for MSPs – in fact, we’ve seen this figure as high as 35%, mostly in the service desk area of organisations. 20% staff turnover rate is a common baseline figure.
Such high turnover rates lead to loss of knowledge from the business, increasing the risk of key person dependencies. Additionally, service quality is likely to suffer, and the ability to onboard clients may take a hit.
Companies with a low staff turnover typically pay well and offer bonuses, coupled with strong and defined options for career progression. Additionally, those with a more modern, flexible culture will typically attract and retain staff more successfully.
2. Is the Target’s technology strategy aligned with business objectives?
Many MSPs set out as a specialised providers before diversifying via acquisitions, and often the technology strategy does not mature at the same rate. This can result in a siloed organisation in which technology and the business have become misaligned.
The consequences of this can be seen in swollen leadership and management teams with duplicate roles, and a lack of ownership in clarity and direction which leads to further duplication of technology across the group.
Product and service catalogues require a technology strategy that is intricately linked with the business strategy in order to ensure that the outward proposition is clear and that the technology is able to support this appropriately.
As a result, governance and decision-making are typically impacted first, followed by medium-term consequences in the form of a lack of a coherent roadmap. This, in turn, slows down growth and increases the likelihood of inefficiencies. As a knock-on effect, costs rise, and growth objectives will be missed.
In our IT due diligence assessments, we look for a technology strategy that is well aligned with business and growth objectives, and it is also an area in which we can support businesses post-investment.
3. Are the Target’s acquisitions integrated?
Many MSPs are highly acquisitive, as they seek to acquire additional capabilities and customer bases.
However, this typically leads to duplication of products and services, along with a duplication of internal systems and processes. Failure to address these overlaps can result in pitfalls down the line.
Through our assessments, we have seen a handful of MSPs that have been successful with their acquisition strategy, and here’s what they tend to have in common:
- They are selective and do not acquire organisations that don’t align
- They have a clearly defined enterprise architecture with an accompanying playbook on how acquisitions will be integrated
- They have strong governance around integrating acquisitions
Businesses that fail to integrate acquisitions well are likely to suffer from scaling issues, as inefficiencies emerge and costs spiral. We have also seen cases where manual processes are put in place temporarily, yet they never end up being replaced by automation.
Some other areas to consider before investing in an MSP
- Technical debt
Regardless of the areas of risk discovered through our numerous IT Due Diligence assessments, MSPs remain an attractive investment target, in addition to being a sector with a large scope for bolt-on acquisitions.
The risks touched upon above are in fact common across many technology organisations and sectors and needn’t preclude an investment. Performing IT Due Diligence will help to understand what risks exist, and what likely costs may be involved, and help to refactor remediation into the 100-day plan.
Thanks to Senior Consultant Lewis Taylor for his vital contributions towards this piece.