Is private equity a breath of fresh air for the channel?
As PE investment in the IT channel grows, what does this mean for channel partners?
"Private equity (PE) firms want to make a 3-5x return on their money over 3-5 years. For fast growing MSPs, it can seem a marriage made in heaven as they need cash to grow quickly," says Simon Chappel, director and co-founder at Assured Data Protection (ADP) about the role PE can play in the evolution of the channel.
He argues that overall PE investment is positive for the channel, bringing more growth capital.
"25 years ago, PE didn't back resellers, but now recurring revenue makes service providers very appealing.
These comments come as a growing number of channel businesses turn to private capital for an initial lifeline in the early days or even growth capital.
Chappell believes PE also has potential to help ease the talent shortage. "More capital means more hiring and opportunities. I've seen PE enable international expansion, especially into the US."
Having worked in private equity and now running an independent, self-funded IT service provider, Chappel provides an informed perspective on the topic.
"I worked in private equity previously, buying businesses for a £1m generalist fund. So, I understand both the acquirer and acquiree perspectives.
"My company ADP has been independent for 7 years, self-funded rather than private equity backed. Running a MSP is tricky cashflow-wise - lots of upfront work before monthly subscriptions start and so many service providers take PE or VC funding.
"VCs don't typically back service providers as there's no product IP, but PE do. Recurring revenue is very attractive to them."
PE has been expanding quickly in the channel and CRN's Private Equity Report 2021 found that of the 283 UK-based resellers and MSPs in VAR 350 at least 63 of them - or 22 per cent - were PE-owned, wtih the number growing year on year.
Vladyslav Kostyuk, a channel market analyst at The Channel Company sees this move as just another evolutionary step as the industry matures and channel companies change leadership.
"Private equity provides an injection of cash to help channel partners expand capabilities through acquisitions.
"This became more attractive after the pandemic bump in financing."
Kostyuk also stresses that private equity brings needed financing for talent, capabilities, acquisitions - things partners must do to accommodate constant change in the industry.
"Strategies and growth plans are devised when companies get bought. For some, it provides a second wind."
Powering growth
MSP Academia is one such PE-backed IT company that in the last few years has been growing and expanding, recently reporting £130m+ revenue and a 22 per cent revenue growth in 2023.
Mark McCormack, MD at Academia, tells us how the move to PE backing came about.
"Three years ago, I and my founder wanted an exit plan to de-risk the business after incredible growth. We wanted the best for staff and customers."
Academia's backing is coming from an individual high-net worth investor rather than a full-on private equity firm.
"Our investor offered backing to get to the next level over 3-5 years, not just provide capital. This attracted me more than a trade sale or venture capital (VC), which may have hard deadlines and different agendas.
"I spent lots of time researching options and speaking with partners before deciding this was the right fit.
He explains how the change was gradual as the company and investor aligned on vision and culture over six months.
"There was no knee-jerk reaction or sudden cost-cutting from the investor," he says.
He stresses, however, how trust and balance are key.
"It was fundamental we the leadership team was allowed to run the business day-to-day while the investor provides advice and helps steer. This balance is now perfect after initially being difficult to find."
McCormack also highlights the importance of the investor having experience growing and selling a managed print/IT services company previously, and therefore understanding the channel.
Is private equity a breath of fresh air for the channel?
As PE investment in the IT channel grows, what does this mean for channel partners?
A change of tune
IT hardware, software and services distributor, InTec Microsystems was acquired by private equity investor Chiltern Capital and its management team, with growth plans to exceed £100m+ in July 2023.
Executive chairman at InTec, Alan Cantwell, explains how things are very different under private equity.
"More structured and rigorous planning and reporting expected versus an owner-managed business. But this brings opportunities to properly plan growth rather than finger in the air estimates," he says.
"There are higher expectations on hitting targets. In an owner-managed business, landing a bit under guidance isn't a big deal. In private equity, any misses need explaining and addressing.
He explains that since the acquisition culture is far more performance-driven with deeper business understanding required.
"This is overwhelmingly positive for bringing professionalism, though we must retain the entrepreneurial culture and values," he adds.
He stresses private equity benefits the channel by professionalising partners through experienced ownership and maximising opportunities, something he says the big distributors already have, but smaller partners can better serve vendors with PE backing.
"If I was a vendor, I'd want a well-run distributor with a growth plan and financial means to stock and promote products versus a small owner-managed firm. Private equity facilitates this."
Is private equity a breath of fresh air for the channel?
As PE investment in the IT channel grows, what does this mean for channel partners?
Leap of faith?
Working PE firms also brings some risks and challenges as well.
Kostyuk, for example, says that "many channel companies have autocratic founder-leaders not prepared to give up control after a private equity buyout and some private equity investors lack expertise in the channel and B2B industry, expecting unrealistic returns.
"Misunderstanding the cyclic nature of channel businesses, they try to make changes too late," he adds.
Loss of control and autonomy is also a risk highlighted by McCormack.
"The benefits can outweigh them with the right fit, but you must be careful of potential culture/strategy changes and consider alignment.
He explains that in his opinion the "bad rep" of private equity firms may stem from risky buy-and-build approaches distracting and hamstringing existing owners.
"But with the right investor, the opposite can happen - more money reinvested to enhance my growth."
Chappell argues conflicting time horizons to be the main challenge of working with a private equity firm.
"As an MSP, I expect to keep customers perpetually if we provide good service. But PE funds exit companies in 3-5 years - they care about shorter term gains," he explains.
"This timing misalignment can pressure MSPs to do things against the long-term customer relationship, like inappropriate upselling.
"But PE are transparent - exit in 3-5 years is in every document. I see both sides, but it can challenge long-term thinking.
As for staff, Chappell says PE ownership creates uncertainty as they know the company will change hands in a few years.
"I can give our team long-term certainty that I'm not going anywhere. PE timeframes are predetermined."
But nevertheless, McCormack, Chappell and Cantwell agree that the benefits outweigh any risks.
"More businesses fail when small and owner-managed versus with private equity or bank ownership," Cantwell continues.
"Staff should feel confident with a PE-backed business and its future if it's well-run, but teams need to perform as PE will review underperformance rigorously. This performance focus should exist regardless of ownership structure."
Kostyuk wraps it up saying: "Overall, the channel's maturation means less startups with venture capital and IPOs, making private equity more likely.
"While the ‘golden age' of channel entrepreneurship fades, private equity at least provides investment to sustain businesses."