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Funding for MSPs: VC investors, angels and other sources

When raising money for your MSP business, several factors will determine whether the best approach is to solicit funding from VC investors or from sources closer to home.

Managed service providers (MSPs) looking to raise money have several financial routes they can take.

Those routes depend a lot on where the MSP stands as a company. Startups may require a relatively small amount of cash for the initial launch, especially since the cost of entry is much lower than it was a couple of decades ago. On the end of the MSP spectrum, a well-established company that has passed the $10-million-in-annual-revenue threshold may raise money for its next round of expansion from a venture capitalist (VC) investors firm.

No approach is without issues, however. Regardless of the investment's size, every source of funding will have its requirements. But perhaps the toughest funding dilemma can be found among mid-sized MSPs, who typically have the fewest options for raising money.

Small MSPs, startups: How to raise money

Fortunately, for MSP startups, the cost of launching is relatively cheap, especially compared to the investments one had to make in the early days of the managed services industry.

"The actual hard costs of getting into managed services today are much less than it used to be 20 years ago. You don't have to invest in a half-million-dollar NOC [network operations center] with enterprise-grade software and hire an architect and engineer that can customize and tweak that software," said Charles Weaver, CEO and co-founder of the MSPAlliance, based in Chico, Calif. "Today, the software is ready to go out of the box. … You have outsourced help desks and NOCs that you can leverage so you don't have to go out and staff 50 people, 24x7 monitoring your NOC."

The costs of starting an MSP might surprise some. According to Weaver, anyone can now single-handedly launch a managed services business for around $5,000. This would cover outsourcing a NOC and helpdesk service, and the price of a software-as-a-service version of remote monitoring and management. This will get you started, but only at an elementary level. The types of customers your MSP could handle would be limited to mainly small businesses that have basic IT needs.

Charles WeaverCharles Weaver

Weaver said friends and family and bank lines of credit tend to be the most commonly used sources of funding for startup MSPs. Michael Corey, president of Ntirety Inc., a database services company located in Dedham, Mass., noted a drawback to this. "If the business doesn't do well, and your father gave you $50,000 of [his] retirement money, that puts a level of pressure on the entrepreneur that's different," he said.

For funding in the ballpark of $500,000 to $1 million, some MSPs turn to angel investors.

These types of investors are interested in investing in businesses like MSPs for a variety of different reasons. "Angels are all over the map," Corey said. On the one end the spectrum, there is what he calls professional angel investors: high net-worth individuals who generally belong to a club or group with other investors, invest frequently, and typically have people that work for them that look for opportunities. MSPs can expect to see their investments come with strings attached.

On the other end of the spectrum are "people who have built businesses themselves, are sitting on a bunch of money, and want to be in the game but they don't really want to work 100 hours a week," Corey said. These types of investors want to be active in business in more of a mentor-like role. But make no mistake,despite their motivations for investing in your business, these types of investors still want to make their money back, he said.

If you work with an angel investor, Corey warned that you should ensure you understand the fine details of a contract. For example, contracts may include clauses that allow them to take control over your company in certain circumstances. A contract could state that after six years they have the right to force you to sell your business, for example. It's becoming more and more common for investors to put tickets in their contracts that protect their investments after a set amount of time, Corey said. The devil is in the details.

The funding dilemma of mid-sized MSPs

Many MSPs plateau in revenue once they reach $2 million to $5 million. At this revenue range, the typical company's managed services revenue will stall and the company can't grow any larger. "You're growing 20% a year, and you've got a 20% client attrition rate. You hit $5 million, and it's really difficult to get north of $5 million. You get stuck there," Corey said.

Michael CoreyMichael Corey

Corey calls this category of MSP companies "the tweenies," mid-sized organizations for which he said there is a gap in the investment market.

VC investors typically like to invest large amounts of money into large companies that have reached $10 million or more in annual revenue, Weaver said.

That $10-million mark is meaningful to investors in that it proves that your company has cleared some general entrepreneurial hurdles. "By the time a company gets to the $10-million mark, usually there's a pretty substantial sales and marketing engine in place and it's going to keep going," Corey said. "Until you get to $10 million revenue, you're still in those throes of, 'Will you survive or not survive?'"

One million dollars (obtainable through angel investors and the like) may not be enough for a tweenie-sized company's financial needs, while a $10-million investment (obtainable through VC investors) is too large. Additionally, at less than $10 million in revenue, tweenie MSPs will not be at a size for most VC firms to take an interest in them.

"If you just want to raise $2.5 million to $5 million, it's harder than raising the $1 million or $10 million," Corey said.

Generally, VC firms are looking to have little risk in their investments, to invest in "the sure thing." When a company gets to $10 million, there's a valuation pop. "It is a much more valuable company, because the risks, if you're investing in it or buying it, are so much less. … Odds are, you're not going to lose your money. They're not going to go out of business," he said. "Until you get north of $10 million in revenue, I would argue you're a risky business [for VCs]."

Michael CoreyPresident, Ntirety

Weaver said MSPs that stall in the $2-million to $5-million range because of growth inhibitors that have nothing to do with technology. These inhibitors instead relate to human resources and scaling issues, and stem from a lack of business expertise. Most MSPs are run by technologists and not by people that have MBAs or finance and business administration degrees, he said. "They've never been trained on how to take a company from where they started it with running a handful of technicians and maybe an office manager and maybe an accountant and maybe an HR person to actually going above that $5-million, $10-million threshold."

An MSP passing the $10-million mark is "like going from the minor leagues to the major leagues," Weaver said. "You're suddenly in a whole new environment where institutional investors look at you differently."

But to get there, the business management side of an MSP has to be as strong as its technical capabilities.

Venture capital as a source of funding

If your goal is rapid growth, one route you might take is venture capital for the financial fuel. Taking the VC approach isn't easy, however.

Before seeking funding from VC investors, MSPs will have to create a package that includes financial models, projections, market data and any other types of research to support its assertions about your MSP's future, he said. With this information, you then need to get in front of the right people and fit with their investment profile. He recommended researching VC firms by looking at their websites to find out who they have invested in, who the senior partners are, and so forth. He also said he has found, a website where people rate VC investor companies, to be a useful research tool.

Once you have the funds, the work continues: You have to focus on setting and meeting the investors' expectations. VC investors tend to sign up with businesses from which they expect an explosive pace of growth, and, just like with public companies, you will have to report how business is doing on a regular basis. "Every quarter, every month -- whatever it is you agreed to -- [VC firms] want to know how the business is doing. They have the right to look up exactly how the business is doing and ask tough questions and push you," he said.

He added that MSPs should understand that most venture capitalist funds have a life expectancy. Most firms will want their money out within 10 years, with six or seven years being the usual length of time.

Whether an MSP wishes to raise money from angel groups or VC investors, it all comes back to what their plan is, Corey said. "If you take money, it can accelerate your growth very quickly. If you don't take money, you might get there a lot slower but, when it's all said and done, you own it, you control it and you do what you want. They both have pluses and minuses along the way," he said.

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