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2024 Insights from the IT Services M&A Frontlines

“Time flies” is an age-old saying that seems most appropriate when reflecting on our 14 years specializing in the IT M&A business, and as I think about what lies ahead. While researching our deal history for this piece, we noticed that a growing number of our transactions are happening with companies we have known for years (sometimes many years) and are finally “ready” to explore possibilities. And similarly, we catch-up with owners who are now ready, but their companies are not much different than when we first met them, so they may have missed the boat on previous opportunities – and suddenly years have gone by without them participating in any upside.

As we enter our fifteenth year, I’d like to share our unique perspective from the front lines and hopefully help IT business owners benefit from our M&A experience in this constantly evolving space, as we look into our 2024 crystal ball, and beyond.

Understanding IT Business Valuation: Trends and Nuances in 2023

This is always the first question on any IT business owners mind, and still one of the hardest to answer truthfully without knowing quite a bit about their company (the simple “Multiple x EBITDA” answer is most often very misleading). That said, there are nuanced guidelines that are worth understanding in order to frame your thinking. In 2023 we witnessed a recognizable shift that reflected the broader economic pulse, but not as one might have projected – it showed up in customer retention. We observed many IT companies experiencing unexpected customer losses, for myriad reasons having nothing to do with a potential transaction. In polling sellers and buyers on this topic, most attributed this to post-pandemic forces at work, where timing became an issue.

Status quo worked to keep customers in place during the pandemic era, but the general business environment experienced all sorts of convulsions in ’22 and ’23, compelling (or forcing) some customers to rethink their IT Service Provider relationship, more so than we have seen in the past. While we don’t see this trend continuing, IT business owners should certainly redouble their efforts on client retention and not take their customers for granted, particularly key customers. Cogent performed greater diligence scrutiny in recurring revenue and customer metrics such as retention, growth, and concentration as a percentage of revenue, to name a few items that will remain under the microscope.

Anticipating IT Business Valuation Dynamics for 2024

“Inventory” of steady annual growth, >$1M EBITDA recurring revenue-based companies was lower in 2023, which kept valuations on the high-side generally, mainly because of all the buyers that have been flooding the market, literally chasing every seller. While this may seem good for potential sellers, it has also caused an increase in buyers who must “pass” on a deal pre-LOI, or are forced to “re-trade” deal terms, because increased due diligence scrutiny often uncovers a large gap between expectations set by advisors or brokers, and fiscal reality from the buyer’s perspective.

In 2024, we believe there will continue to be more buyers than sellers in the market. Operators of all sizes are attempting to become buyers, and those companies with buying experience are continuing their push to grow via acquisition. Private equity (PE) backed IT companies will also continue their efforts to grow their current operating platforms, with some ready or almost ready for their next liquidity event. Thus, we think this year should be very active for well-run companies in the >$1M to <$3M EBITDA size range. As in years past, the >$3M EBITDA companies will be in high demand by buyers of all types, and the scarcity of MSPs in this size range will shore-up valuations, but only the most well run, or “specialized” companies will be able to command a premium purchase price.

While Interest rates negatively affected some buyers who use a substantial amount of “leverage” (debt) in the >$5M EBITDA strata, this category is always in high demand and this trend will continue in 2024. Interestingly, we did not see the same impact on <$3M EBITDA transactions, since these buyers tend to rely less on leverage and use more of their investable “dry powder” from reserves or their PE’s fund capital (with >$3M to <$5M EBITDA companies straddling this position, depending on their unique situation and attractiveness to the suitor pool). We believe demand will remain high across the entire IT Services space and that valuations will remain attractive for sellers of >$1M EBITDA IT businesses generally. We also expect activity to increase in the >$500M to <$1M range, as has been the case in the last few years. Additionally, we saw “mergers” in this EBITDA range were at an all-time high in 2023, and we think this will continue in 2024.

Cybersecurity and Compliance in MSPs

MSPs are continuing to prioritize advanced cybersecurity offerings to protect their customers and help them comply with changing regulations. TSP industry leaders continue to stress the importance of steady investment in state-of-the-art security technologies and staff training, promising to open new avenues for IT Services companies to expand, though blurring the lines between the definition of an “MSP” and a “Cybersecurity” company in the process. We believe IT Service Providers that fully embrace cybersecurity services and excel at rolling out these solutions to their customers, will continue to distinguish themselves from their competitors.

However, cybersecurity in its many guises means different things to different people, as this portion of the IT Services space is by no means standardized. This can create misalignment on value and expectations if the suite of cyber security services is not clearly defined and well understood by all sides early on in transaction discussions. Value is what you make of it, so reciprocal alignment is key when cybersecurity is part of the service suite. Generally, strong cybersecurity capabilities enhance a company’s attractiveness in M&A activities both as a buyer and as a seller, underscoring security’s increasing role in IT company valuations.

AI’s Transformative Role is still Unrealized

While AI’s infusion into MSP offerings may become a game-changer someday, maybe even in the near future, we have not uncovered a direct correlation to valuation yet. It will be important to see correlated monetization of service offerings and the unlocking of cost savings from operational efficiencies — which has not yet materialized at the IT Services company level – before AI can be a contributor to enterprise value in this sector. We do believe a proactive embrace of AI places those IT Services companies at the vanguard, poised to potentially reap rewards well before laggards, but there is a long way to go before AI can become a driver of IT Service company value. We will be paying close attention to how AI capabilities influence efficiencies and margins in IT service providers, and thus gains in enterprise value, as time passes.

Strategic Financial Governance as a Valuation Lever

In our experience closing >170 IT company transactions (and still counting), all TSP’s and IT Services companies can gain a competitive edge in M&A with consummate financial governance and unsullied company records. Strong financial practices are the linchpin for navigating M&A reliably, giving firms on both sides of the table the ability to capitalize on opportunities ahead of slower-moving and less well managed rivals.

In our business, where deals hinge on precise timing and financial transparency, the value of rigorous financial protocols cannot be overstated. It’s not a new trend, but a practice we will continue to evangelize as a major influence on immediate and long-term success. We counsel all IT owners, even those not contemplating immediate sales, to consider the strategic refinement of their own financial operations and immediate priority. Establishing clear, organized financials is not merely about being acquisition-ready; it’s a hallmark of a well-run business poised for sustainable success.

Such preparedness doesn’t just attract potential buyers; it imbues firms with the confidence to act decisively at pivotal moments. In the IT Services market, nuanced differentiation lies in operational readiness and the ability to transact without hesitation. Companies that heed this call for financial diligence will find themselves at an advantage, both now and as future market conditions evolve.

Personal Insight and Future Outlook

At Cogent Growth Partners, our unwavering commitment to champion transformative M&A outcomes that help propel our clients and partners to the forefront of the industry, has produced myriad success stories and long lived client relationships we still enjoy today. As we look forward to participating as a catalyst in the evolving IT Services story, we think adaptability and strategic foresight are not just valuable — they are imperative. In a period of continuing transformation, the IT M&A sector will certainly be brimming with opportunities in 2024, and we look forward to helping everyone on both sides of the table realize their potential.

Want to learn more about IT M&A? Next month, we’ll begin publishing a new monthly newsletter dedicated to sharing Cogent’s deep well of educational resources, along with insights and current trends. Our goal is to help you embark on your own M&A educational journey and help you harness your ability to achieve unparalleled success.

Wishing you a thriving and prosperous year ahead!

Rick Murphy
CEO and Managing Partner