NOW is the Time to Think About Your Exit

Managed Service Provider owners have a lot on their plate. Client issues, billing issues, thinking about security, making and managing payroll, among other things. One thing that often gets missed is thinking about the exit strategy and where the MSP business owner wants to end up down the road.

Determining when, how, and the ultimate value of your exit is a vital business strategy that MSPs should think about. That’s what I’m talking about today.

Why should I have an exit plan?

Why should you plan for your exit? Simple, when you build a target you will head in that direction. Thinking about selling or exiting from your MSP might not be something that’s happening soon, but it will happen some day. Time, as an opponent, is undefeated. So, having a target in mind with some thought put into it will improve your business better than just going day by day and doing whatever is on tap.

Build your exit plan and you will see better business growth just for the sake of having the plan. Heck, you can change your plan and STILL be better off than having no plan at all.

When should I exit?

This one is an individual answer. Only you can answer it for yourself. The key is that you need to think about how much longer you want to work, and whether or not you want to fully exit or perhaps just exit the day-to-day.

Usually your exit plan lands in one of these categories:

• 3-5 years and you have a good idea about whether you’re closer to 3 or 5 years
• 5-10 years and it’s a bit more nebulous – you know you’re not ready to leave yet, but you see the exit out there on the horizon
• 10+ years and you know that you’ll exit some day, but it’s not for quite some time

No matter where your exit timing is know that the closer you are to the exit the shorter the runway. If you are dealing with a short runway you need to make smart decisions in your Managed Service Practice NOW.

How much is my business worth?

True business valuation is left up to the pros (I recommend talking to IT Valuations or Delmar Insights), but I’ll give you some back of the napkin math you can use to gauge where you are. That said, let’s talk about a couple of concepts first. Similar to my pricing strategy I like to begin with the end in mind.

Determining your post sale income needs

When you think about your exit out of your business, think about how much income you must have to live on. If you think about a conservative investment strategy (and talk to your financial professional for actual advice) you should be able to clear about $50,000 in income for every $1,000,000 invested without hurting your principal. So, if you need $150,000 in annual income after the sale of your MSP you need about $3,000,000 invested.

Determining a $1,000,000 valuation (and extrapolating further)

To make this easy let’s talk about what it takes to get a $1M valuation. It’s worth noting that when your MSP is <$2M revenue your valuation might be a little lower than expected. It seems that the smaller MSPs are a bit less appealing for some of the higher multiples out there.

When you consider what it takes to get $1M of valuation you need to think in terms of Adjusted EBITDA (see below for an explanation of Adjusted EBITDA). If you are able to pull $200k in Adjusted EBITDA in a year you should be in that $1M range for valuation. This gets a bit more clear as you get north of $2M in revenue (see my note above).

So, if you are looking for that $150,000 in income as mentioned above you need about $600,000 in Adjusted EBITDA.

What is Adjusted EBITDA?

Adjusted EBITDA is a modification of the EBITDA term that I talked about in this post. The adjusted part is important because it normalizes a “fair” market salary to replace you as the owner/president/CEO of your business.

Often, owners underpay themselves and collect money off the balance sheet as distributions. When this happens, the EBITDA number is artificially high. So, Adjusted EBITDA takes into a reasonable owner salary into account. Generally speaking, owner salaries should be between $150,000 and $200,000. This is always a little variable, but this is a decent figure for back of the napkin purposes.

For example, if you pay yourself $50,000 salary and the rest as distributions you need to account for the additional $100,000 that you’d have to use to pay a replacement. Meaning that your Adjusted EBITDA would be $100,000 less than your normal EBITDA.

Putting this all together

So, if you need $150,000 in income after the sale of your business you need $600,000 in Adjusted EBITDA. If your normal Adjusted EBITDA percent is in the 15% range (which is doable) you’d need about $4,000,000 in revenue. That said, if you can pull 20% Adjusted EBITDA you’d get there with $3,000,000.

This is where knowing your numbers, driving good Gross Margin, and keeping an eye on your below the line expenses really come into play. Pricing your agreements well helps too.

Determining where you want to take the business is an important step, but executing well on your plan is much more critical over time. Execution is where the real work begins, but you can do it. I believe in you.