How to Calculate Adjusted EBITDA for MSPs (and Why It Matters)

Ever feel like valuing a Managed Service Provider (MSP) is like staring into a black box? The profit and loss statement might not actually reflect what a business is truly worth. Whether you’re considering an exit or looking to grow through acquisition, there’s one key financial metric you absolutely need to understand: Adjusted EBITDA.

In this post, we’ll pull back the curtain on what Adjusted EBITDA is, why it’s important for MSPs, how to calculate it properly, and how it impacts valuation.

What Exactly Is Adjusted EBITDA?

EBITDA of course stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. Adjusted EBITDA goes a step further by normalizing earnings to reflect the real, ongoing profitability of your business by removing personal expenses, one-time costs, or income/expenses that wouldn’t carry over to a buyer. In short, it estimates what a new owner could reasonably expect to earn post-acquisition.

Why Adjusted EBITDA Matters

A multiple of Adjusted EBITDA is the most widely used metric in MSP valuations. The biggest factor influencing the multiple is how much top line revenue there is. For instance, a small, solo MSP generating low six figures might trade at roughly 2x Adjusted EBITDA. But a larger MSP with $10M+ in revenue could see a multiples as high as 8–10x. Here are some other factors which influence the multiple:

• Recurring vs. Project-Based Revenue: More recurring revenue is desirable.
• Profit Margins: Healthy margins indicate efficient operations.
• Geographic Market Size: Larger markets mean more competition vying for acquisitions.
• Client Concentration: A diverse client base is less risky.
• Owner Involvement: How much “key man risk” is present?

The Common Adjustments

When you’re crunching the numbers for Adjusted EBITDA, the main goal is to adjust the P&L to reflect which revenues/expects a buyer would actually inherit. Here’s a breakdown of what might typically get adjusted:

Expenses to Add Back

These are costs the seller incurred that a buyer wouldn’t expect to absorb.

• Owner’s Personal Expenses: Personal travel, meals, car costs, or even family cell phone plans that run through the business.
• One-Time Costs: Was there a big office renovation last year? A one-off legal settlement? Or a costly website redesign? These are typically added back as they aren’t expected to reoccur.
• “Ghost Employees”: If there’s family members on the payroll who aren’t really contributing, those salaries are typically added back.
• Owner Compensation: This is a big one. There are two adjustments, which together aim to estimate the market value for replacing the owner’s role. First, the owner’s salary is added back. Then, you subtract the fair market cost it would take to replace their role post-sale. This is helpful in circumstances where the seller is paying themselves more (or less) than fair market value for their role.

Non-Operating Income to Subtract

These are income items that aren’t part of the core, ongoing operations of an MSP.

• Government grants or subsidies.
• One-time legal settlements received.
• Rental income (i.e. from subleasing office space).
• Proceeds from selling old equipment or other one-off asset disposals.

Why Reasonableness Matters

It’s in the seller’s interest to maximize Adjusted EBITDA to boost their valuation. But it’s important for sellers to be reasonable, because inflating add-backs or being overly aggressive with your adjustments can backfire. Buyers will scrutinize add backs, and if a seller’s add backs are unreasonable, it can seriously damage trust and potentially even derail a deal.

Want to Go Deeper?

We hosted a webinar titled ‘How to Calculate Adjusted EBITDA for MSPs’ that walks you through the methodology using a fictitious MSP’s P&L and discusses the impact on valuation.

Watch the webinar here: YouTube – How to Calculate Adjusted EBITDA for MSPs

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