Private equity and venture capital funding trends in the managed services space

Money is still being invested in the MSP space despite economic concerns 

The private equity and venture capital communities have always shaped the MSP landscape at both the partner and vendor levels. Many have wondered if economic challenges in 2023 will lead to a slowdown in the high rates of investment seen in the last few years. The answer is, as always, mixed. 

Top-level trends show private equity investment is still as strong as it has been for several reasons. Primarily, funds are invested for years at a time and that doesn’t suddenly shift based on current economic headwinds. But to access the kinds of returns expected previously both private equity and venture capital are looking for specific verticals and capabilities. 

Cybersecurity and financial tools will remain among the top priorities on the investment ladder, but, equally, companies providing vertical-specific technologies will see continued investment. These include, for example, companies offering AI software designed for IoT applications in the oil and gas industry, or automation tools in financial services. 

Venture capital has slowed slightly, but it is a myth that money was being thrown around before the current economic crisis. The kind of multiplier model used by VCs to determine the strength of their investments remains essentially the same, it is simply that valuations will be lower because there is generally less money in the market. Uncertainty and high interest rates always drive a wave of cash-holding activity in some areas, but there is still a strong desire to capitalize on lower valuations. 

Specialization is key 

Firms that specialize in one area will be more attractive than those that attempt to broaden their approach. This means that a firm, be they a vendor or an MSP, will likely be more attractive if it focuses on one specific area of cybersecurity, rather than one which is created to offer broad solutions. Differentiation is vital to stand out at a time of lower customer spending, and an MSP that excels at cybersecurity posture and compliance consulting will likely see stronger investment than one that attempts to emulate large service provider models. 

Remember, of course, the end goal for many start-ups is to be acquired by a larger established firm. This form of exit within a short timeframe is also most desirable to VC firms. The most attractive firms for acquisition are those that offer a highly specialized technology, being acquired by a larger firm that is looking to build these capabilities. 

Profit will be more important now, but hidden expenses will also be scrutinized more strongly 

One of the strongest narratives around PE investment (and VC to the extent that quick routes to profitability for start-ups are more desirable today) is that loss-making firms will be left high and dry once the tide of cash moves out of the market. 

While this is echoed by some investment firms and experts, it is more complex than this. Profitability is measured in many ways. One that is often not scrutinized as closely during times of high market capitalization is stock-based compensation. These kinds of hidden expenses are currently under the microscope, particularly in start-up software firms where top-level engineers can command relatively high equity compensation.

Even firms whose valuations have heavily declined this year report issuing almost three times the amount of stock to key employees in 2022 as they did in 2021. While many are saying that large tech layoffs will drive down salaries, the value of a good engineer or manager with a strong track record is always high (and right now is arguably higher given the economic issues faced by software firms and MSPs). 

While private equity and venture capital funding is being more carefully apportioned, the investment landscape is still strong. In some ways, their money buys more today than it did 18 months ago, so they can afford to spread their risk even further. For those that specialize and are transparent about their profitability, there is clearly still money to be found in the technology industry.