How to sell a small business in the IT services, VAR space

Determining the valuation and prepping for sale

The key component in determining the value of a business is EBIT -- earnings before interest and taxes -- writes Sheldon Kralstein, in How Much is Your VAR Practice Worth? Generally, he said, EBIT is evaluated by looking at the current year, the prior two years and a forward projection of one to two years. A VAR with consistent, growing and predictable earnings would achieve the highest valuation, Kralstein said.

It's more difficult to sell your shares in a privately held, small business. You have to find someone to take care of your customers and pledge not to gut your employees.

Charlie Weaver, president and co-founder, MSPAlliance

"A well-run business achieves a healthy EBIT while having investment capital to propel growth," he noted. One wrong-headed notion about business valuation, according to Kralstein, is that an EBIT might be low because a company owner made an investment in growing the business. This is not an acceptable reason, he said; the growth needs to be ongoing and always funded.

"High valuations are achieved through a balance of consistent EBIT and growth," said Kralstein. "Both are achievable with a sound business plan and accounting principles."

In a best-case scenario, concurred Weaver, a business has kept good books for a year or more and has documented and prepared the company for a maximized valuation. "Think of it as … you're cleaning house and you need to make it presentable. The same thing goes for a corporation, and there are things you have to do to make it presentable to someone else."

How to make it presentable? Think of things that could enhance that valuation, Weaver said, such as paying down your debt or line of credit, or getting more aggressive about acquiring new customers. He also advises documenting your policies and procedures and trying to improve your margin. Again, Weaver emphasized, "if the whole company depends on you as owner or CEO, it's going to be really hard selling it."

Finding a potential buyer

For those managed services companies that have prepared well for an acquisition, there is no shortage of companies that want to invest, Weaver said. The question is how do you go about finding them?

He says you need to make your intentions known -- either through an intermediary that specializes in mergers and acquisitions [M&As] or through existing contacts. "It's a small community we live in, globally," Weaver said. Trade shows and conferences are also good ways of putting your name out there.

It's good to talk to other providers in the community since there could be other VARs interested in making an acquisition, which is one method of succession planning, he said. Another option to consider is a merger with a like-sized company. Weaver cited the example of software vendor Kaseya, which was acquired earlier this year by investment firm Insight Venture Partners, which bought out the three original shareholders.

"In that scenario, they had good succession planning because they knew down the road they would want to sell," he observed.

Finding a buyer usually boils down to a combination of timing and having a good brand that your peers know about, said Weaver. The ideal situation is being at the peak of your brand awareness in the community, having a financial story that backs that up and then meeting someone at, say, a networking dinner and finding yourself in a discussion about an acquisition. But, he acknowledges, there are not many cases where things fall so neatly into place.

Weaver said that right now he knows of about five or six MSPs actively trying to sell either due to illness or because they want to retire or are tired of running a business, which he said is a fairly typical number. "It spiked up before some of the [US] tax hikes that were anticipated that drove a lot of companies to do deals before end of 2012."

Examples of how to sell a small business  

One example of a successful M&A is ABC Services Inc., which acquired Progressive Technology Group in 2012. The two companies had worked together for over 15 years, said Thomas Kempster, president and CEO of ABC Services, which is based in Melville, N.Y. He said he approached Island Park, N.Y.-based PTG about joining forces because "over time, our close working relationship, trust and seeing the value of our combined resources made the idea of merging extremely inviting."

Kempster's advice for VARs that are considering merging: "[Mergers] should be pursued when both parties find value in working together and want to expand their resources or offerings under a single brand."

Another example is Boston-based Covisia, which was acquired in March 2012 by All Covered, a division of Konica Minolta Business Solutions based in Foster City, Calif. The former CEO of Covisia, Bill Fistori, said he always maintained an acquisition strategy while growing his business.

"To grow aggressively in the managed service space is very difficult to do in organic sales alone," said Fistori, who recently started a consulting business called WG3 Advisors LLC, working with software companies. "I've seen a majority of companies in our space struggle with sales growth … because a lot of that is executives selling to a certain degree, which can be hard to replicate with a sales team." While you can grow a sales team, he said, "typically you can't get to same level of sales that owners of a business can, so it's very difficult, but not impossible."

Any managed services company looking to grow should have acquisitions as part of its strategy, he emphasized.

Like Weaver, Fistori said you also have to run the business like you're going to sell it: Ensure your books are clean, stay current with the financials; make sure there isn't a lot of debt; keep records of monthly metrics; and make sure there are no legal issues. He said the typical benchmark to show a prospective buyer is at least three years of consistent sales growth.

"This will put you in a much better negotiating position," and it's also very important to have a good management team in place so that the business doesn't rely solely on the owners, he said.

Fistori also said if the business has "consistent dips and peaks and valleys with sales, has inconsistent growth or is flat, you most likely will not be in a great position of strength during a negotiation."

If you can demonstrate growth, however, "you hold the cards."