EPISODE 231. The team demystifies EBITDA multiple arbitrage for IT services leaders! Talking what it is, why it works, and how to capture the upside without stepping on landmines. Mike lays out the math behind buying smaller, healthy firms at lower EBITDA multiples and selling a larger, integrated platform at a higher multiple. Matt explains why scale alone isn’t enough: the winners broaden capabilities, mature processes, and move up the value chain. The crew digs into the seller’s calculus on rolling equity (hello, second bite) versus cash at close, plus real risks around dilution, culture fit, and execution. Then they get practical: what great integration looks like, where synergy is real (not imagined), and why revenue and profit velocity command premiums. They close by weighing strategic buyers versus PE-backed platforms and the questions every seller should ask before “joining the roll-up.”
02:39 — What is EBITDA multiple arbitrage (plain-English walk-through)
03:39 — Why smaller firms trade lower and platforms trade higher (the math)
07:50 — Beyond size: capabilities, service lines, and moving up the value chain
11:49 — Rolling equity 101: the “second bite” and a typical 70/30 construct (example)
15:03 — Risks sellers must vet: culture, strategy, dilution, and capital stack terms
19:56 — Integration that creates real accretion (when 1+1=3…or more) + “velocity matters”
23:46 — Is there a cap? Where arbitrage gains flatten as platforms scale up
27:55 — Can strategics do this without PE? Funding paths and “smart money” mindset
1:49 | Mike
Hello, and welcome to this week's Shoot the Moon podcast broadcasting live and direct from Revenue Rocket world headquarters in Bloomington, Minnesota. For those of you that tune in regularly. And even those that don't revenue rocket are the M&A people we focus on IT services companies with me today, are my partners, Ryan Barnett and Matt Lockhart, welcome guys.
2:16 | Matt
Good to be here, Mike, and well, we know what time of the year it is because football season is in, it has started. It's the fantasy football teams are the, you know, the trash talking has already begun. I mean, it's going, what's going on Ryan?
2:39 | Ryan
Yes. Well, dynasties are clashing out on the fields. We also have dynasties created every day in the world of IT services. And today we're looking at a subject of how to create your own bit here. And it's an interesting topic we've seen a few times in the past and seen it a couple times even this week. And the idea is how can you create a larger company that utilizing the concept of EBITDA or arbitrage? And if you're new to merchant acquisition, this is going to be a topic that might be a little bit more advanced, but I think it's really fascinating. And, and Mike, I'd love for you to just get us started. What is well, let's even start out. You know, how are deals typically looked at, in the IT services space? And, and also what does EBITDA multiple arbitrage really mean? What's that mean in just plain English?
3:39 | Mike
Yeah, sure thing, Ryan. So, you know, deals in the IT services world, tech enabled services world are often built on a multiple of EBITDA, a multiple of trailing 12 month EBITDA earnings before interest, taxes, depreciation, and amortization, and… that number… usually is a lower for smaller firms and larger for bigger firms. And so, there is a natural opportunity to aggregate firms that are smaller ones that are healthy and growing. And, you know, trade a specific multiple into a larger firm that as an aggregate firm are one that's larger would and would command a higher EBITDA multiple. So that's to give you a simple example, oftentimes IT services firms may acquire firms that, you know, five or six times EBITDA… for the smaller firms. And because they're larger, they may trade, you know, upwards of seven, eight, nine or 10 depending on their size. And so, there's certainly a move afoot to buy a firm at fair market or aggregate many smaller firms at fair market. And then be in a position to, you know, have that contribute to overall enterprise value in a larger firm at a higher multiple all.
5:24 | Ryan
Right. Thanks, Mike. I think there's a few things to unpack here. So what you mentioned is that deals in our space are often traded on a multiple of EBITDA. What I heard you infer was that there's a few ways that, in which that EBITDA can be adjusted. So, for example, a deal in our typical space, let's say you are a managed service provider. If you're typically under a certain threshold of EBITDA today, let's say under 500, 000 dollars or even under 1, 000, 000 in EBITDA. That's going to trade at a range that is typically lower than someone that is trading in a much more a much solider position. So if someone is at four times EBITDA or four 4, 000, 000 in EBITDA, they're going to char, you're going to be able to sell that company on an open market for a much higher level? Is that the simplest way to think about this, I'm buying low today. And size is a component that goes in to the EBITDA multiple calculation. And because size is such an important factor as we grow and become bigger, we can start to leverage that size to solicit larger offers from larger firms. Is that a good way to think about that?
6:41 | Mike
Yeah, for sure. You know, it's a buy low, sell high world as we guys, as you guys know. And so certainly, you know, when you think about how a typical thesis of a sponsored company or private equity firm, maybe to buy a platform at a higher multiple?
6:58 | Matt
Aggregate.
6:59 | Mike
a bunch of smaller firms in there called tuck in investments at lower multiples to further enhance that multiple before they might, you know, exit that investment. And it certainly has worked for decades that way in various industries including ours and continues to do so with the prolific acquirers that are out there today. Sure.
7:24 | Ryan
Okay. So, matt, I guess I would love your perspective here, but what do you think the main drivers are in larger firms earning those larger multiples? Is it all about the scale that I had mentioned earlier? Or does, do you start to look at service lines and customer diversification? Do they start to play just as big of a role to start commanding those premiums?
7:50 | Matt
Yeah, Ryan, I think that, you know, obviously, from a baseline perspective, size matters, right? There's just more stability if you will in size and scale. But then as you start to look at what creates, you know, size and scale and stability, you're really looking at the value that you can provide to your customers in the marketplace… by having greater numbers. You naturally have a more diverse set of capabilities, a wider set of capabilities just because of the numbers and capacity of your team, right? And that matters, right? Because more and more customers are looking for partners for service partners that can do more for them. And by being bigger, you just have the ability to have more capability. And that capability, is in the people. But also, to your point, Ryan, it's in the service line, right? And, you know, so I think that, it really is about being able to demonstrate that you're moving up the value chain not just in your size but in your offerings, your capability. Also naturally, the larger a firm gets, quite honestly, the more money that they have to invest in continuing to grow their capabilities and mature their processes, right? So they can be a best of breed provider. And, you know, that doesn't always happen at times. The arbitrage game can simply be just the growing in scale and size. But the very best firms use that opportunity that they have as they are growing as they are acquiring different firms to really broaden out. And, you know, and increase, their capability.
10:15 | Ryan
Right, right. It seems like if you start combining a few companies, that are like and you're able, to put these firms together. And sometimes it could be a group. I guess maybe a question later. I'll ask later. But if you're able, to put these firms together, and build something better together, there's that uplift in that even just on how you're working and how the firm is growing. This concept sounds really exciting from both a buyer perspective and a stellar perspective. If I'm buying a bunch of firms and, I can start to see that there's a pretty decent exit that allows me to essentially buy low but also sell at a multiple. It's not even just buying higher. It's selling it's really selling at scaled multiples. And if I'm a seller and I sold my firm to a company that's doing this EBITDA multiple arbitrage, I'm starting to think how can I, instead of getting five X EBITDA for my firm today? Or if I take five X today, in the future, I've got a chance at something just much bigger. I mean, Mike, how does someone start to think about, you know, should I start to consider doing this? Like how exciting is that equity opportunity perhaps compared to taking cash, and walking away? I mean, how do you start, how do you start to decide whether to take one of these paths?
11:49 | Mike
Well, certainly, you know, as a smaller firm who may be a tuck in as an example, you'll likely have an opportunity to what we call role equity. If you've listened to any of other, our other podcasts, you'll understand that. Typically, these sponsored or private equity sponsors, you know, want some portion of consideration that's paid for your firm, to be in this quote unquote equity role. And the way you can think about that is you're transferring a portion of your value or equity for the equity value in the sort of parent or, the acquiring company. It's a great way for you to participate in this EBITDA arbitrage, because that portion of equity that you're rolling certainly will be valued at that enhanced multiple when that next recapitalization or change of control, for the parent company happens. And so, you know, I, there is no one size fits all here, but certainly, it's not atypical, for a buyer in the private equity world to, you know, acquire 70 percent of a firm and ask that owners roll a 30 percent equity into the, a larger company that 30 percent equity. Let's say you trade it at six, you know, maybe worth nine or 10 now because, you know, you're now in a position that when that bigger company is sold with your company and as part of your company is part of that larger entity, it likely will trade, at a much higher multiple. If the plan works and it's executed well, and, you know, you're part of that overall… delivery and execution team if you want to call it that, regardless of the role you play and the ongoing entity, you know, then that investment can grow not only with the additional acquisitions that would come after you and the organic growth of the all out business, but also just based on leveraging this heat it up arbitrage.
14:14 | Ryan
Here. So, so if you start to think about this as a seller, you've got some great opportunities on a new place in the organization. Continuing we call that selling in your influence on the company, the opportunity for that second bite at the apple, which could be really substantial. We've seen the second bite of the app will be bigger than they all cashed in up front. In several of the deals that we, we've seen matt, I'd love to understand kind of what's the converse of this, but what risks should sellers be aware of when rolling equity in the platform? Are there things like dilution or loss of control or capital calls? Did you start to think about that? Could make that? That gives sellers a little bit of pause before considering going all in a platform like this? Yeah?
15:03 | Matt
Great question, Ryan, I think as for those who've listened to the Shoot the Moon podcast know three things need to come together in any opportunity, cultural fit, strategic fit and financial fit. And in talking about EBITDA arbitrage, we naturally talk a little bit more about the financial fit. However, you know, it is just absolutely critical that you are joining with a platform. If you're a seller and you're looking at a, at an arbitrage opportunity. That makes sense. That makes sense strategically that you can see the pieces coming together that you see the leadership and the vision from the leadership to be able to integrate firms well, to have everybody rowing the boat, in the same direction because, you know, we've seen scenarios where people are trying to roll up and towards this EBITDA arbitrage opportunity yet not do it so well. And, the firm is actually goes backwards in terms of their organic growth and that's not a good thing, right? That's not a good investment. You're looking at this as an investment. And so you need to look at it from that standpoint, multiples are not guaranteed, right? You know, there's there are ebbs and flows in the market and, you know, cycles matter how you are classified, the equity that you roll and how that equity is classified is absolutely critical. Are you Peri, pursue, right? Is the term in the industry with the original owners or with the private equity group in the business as additional equity is delivered to future buyers. What does that mean for your equity? Is your equity diluted in that scenario? All of these things need to be understood that's why you work with an M, a advisor like revenue rocket because we've seen it all and have a great deal of experience in these types of opportunities. But yes, as with anything, there are risks, there's operational risk. And, you know, one of the things I didn't touch on was culture, and that's important. Again, we've seen sort of both sides to the story here where a founder, you know, recognized that they were at a point and where it was going to be difficult to scale their business. They saw an opportunity to join with a group and roll equity and find that two bites in the apple and they had the opportunity to participate through their own leadership and their own experience to assist and to continue to develop that firm. And, and that's what you know, we look to put together. We have seen other scenarios where it was just a cultural mismatch and the seller came in, you know, full of piss and vinegar and ready to go. But the opportunity did not transpire. And, you know, they retained, their investment but they didn't get to participate and that's really what they were looking to do. So, you need to, you really do need to look at the opportunity as an investment as a financial investment, but also as a personal and professional investment and make sure that all of those fits come together, right?
19:05 | Ryan
Man, I think you just kind of nailed something we need to dig into is that, you know, what does a company really need to do well in order to pull this off? And so what should a buyer realistically expect from an arbitrage scenario in the IT services world? Like is this automatic, what you just mentioned, there's a lot of work that needs to get done. And so, you think it feels like you need things like integration and growth to really make it work. Mike, I'd love to get your perspective on this like, you know, let's talk about integration a bit. If the whole arbitrage plays is really depends on creating a bigger more valuable partner or a company. Pardon me, what does the integration have to look like in those firms for that value to really materialize?
19:56 | Mike
Well, you know, I think as we talk about integration in particular, there's opportunities to enhance all up, you know, you're going to remove redundant functions in the business or, right size them or be able to leverage them in ways where, you know, one plus one really does equal three. And I think, you know, just the logical nature of adding more EBITDA which you know, is a proxy for, the general size of the business and impact multiple. Like we've talked before, you know, is accretive. So being able to effectively do integration in the, you know, in a way that does really, we use this term loosely. You know, it does create a one plus one equals three or four or five, being able to not only save money on integration but also create new opportunities together that you couldn't create apart for the, if you will the now combined business all drive towards that larger even a pie if you will not larger even a pie as it continues to grow, you know, post transaction now organically and probably continues to grow through other acquisitions. You know, delivers on that promise of, you know, being able to trade again later at a much higher multiple. I think it's also critically important to point out that, you know, trajectory matters, velocity matters both for revenue and profit in overall valuation multiples. And so, you know, if you're able to be sort of in the top, at least in the top quartiles, not higher, maybe in the top, you know, five percent of industry peers as it relates to revenue growth and profitability, you're going to be in a position to command a premium for not only the multiple, you know, when it comes time to do a deal, but also for the number of buyers. It would be interesting that tends to drive competition and tends to drive up, you know, real offers in general. And so, you know, all that's really important stuff vis a vis integration and ultimately getting to a higher end game number in the arbitrage game.
22:42 | Ryan
And that's it. Yeah, I hear what you're saying like, and when you think about these firms overall, I guess one of the questions when you're talking that came to my mind was, is there a, is there a size cap of what it takes to make this arbitrage to continue to work? Like the examples we've thrown out have been a firm that maybe starts at five… X EBITDA, so, a firm that may be less than a 1, 000, 000 in EBITDA, but ultimately, is there a cap of how large this goes? It seems like we've already seen companies in the MSP space, take advantage of this through some of, the acquisitions that are there, is there a point where is there always going to be a larger Fish that can make this play happen? Either? Mike, matt, feel free to answer, that question.
23:46 | Mike
Well, I think the answer is probably yes within reason, and what I mean by that is in a consolidating market which we see in IT services, in all areas of IT services where there's great demand for sticky, you know, recurring revenue models… ones that deliver high value, whether we call it repeat or recurring revenue models. But, and our really the final mile if you think for many types of technology firms and IT services, you know, there's a, an insatiable demand from end user customers for that service. And so that will tend to create a lot of interest from capital markets. And it will tend to also create bigger and bigger… opportunities for cons, you know, consolidators that are building larger and larger firms. I think to a point where, you know, what happens with these large firms when it comes time for them to take advantage of their EBITDA, arbitrage, you know, it probably means that they may go public. They may be acquired by a public company. They may be acquired by a very large private equity firm. That tends to do, you know, transactions into the double digit billions if they're large enough. But I think, you know, to get to the base question, you know, the evil even arbitrage game continues to play along. Now, the biggest gains in email arbitrage, EBITDA, arbitrage, however are with smaller firms, probably in the 1, 000, 000, I don't know, 15, 20, 000, 000 dollars in EBITDA range that range, you're gonna see much bigger gains in the arbitrage between kind of one and 10, 000, 000. And, you know, above 10, 000, 000, you'll certainly see them continue but they start to flatten out because there's just, a logical sort… of cap on where a buyer regardless of who they are and regardless of their capacity… can get a reasonable return, right? You can't you know, for the rest of your life can't you know, continue to double down on, you know, the multiple can't go from five to 10 to 20 to 30 to 40 because it just, there's a point at which those buyers just can't get a return on some crazy multiple. And there's proxies for that in the public markets. Like if you see a public markets, you know, where do certain firms trade, you know, they, some of them trade kind of in the 20 to 30 in the tech space, 20 to 30 times even a multiple that's probably a theoretical limit, right? Where you would become a super large firm getting to a multiple that, that's probably the top end. So that's just sort of another data point. So, you know, where this arbitrage game works best is probably in the single digit, even the multiples, and the low double digit, even multiples.
27:15 | Ryan
Yeah, thanks, thanks, Mike. I saw a lot of the questions that I had here today. I guess I part of this is that if you're considering being part of a organization, that does this, what kind of questions, do you need to ask the firms that you're looking to partner with in this? And again, the other question, I guess that's on my mind is can a strategic company pull this off or do you almost always have to have a backing of a financial sponsor or private equity type firm, to make this happen?
27:55 | Matt
You know, Ryan, you're going right where I was thinking, no, no, yes, yes, yes, a strategic opportunity can result in the arbitrage game as well as a matter of fact, we've had multiple clients where we've assisted them, and they created their own funding ability through bank funding, through SBA funding, through their cash reserves in their own business. And, you know, oftentimes what you'll see there is, it may be a little bit longer road, to travel in that scenario. But the premise, is still the same if you find very good fits, cultural fits, strategic fits and very good talent that you can bring on board to be part of your organization. You can find, this EBITDA arbitrage opportunity. Now, oftentimes what we see most of is that there is some investor backing, private equity backing is most common, but that private, the very best firms have sort of the nature of a strategic buy that is backed by good capital reserves. And so in, you know, both of those scenarios are possible, and to sort of kind of lean into, the start of your question, as a seller, I think that you really do need to first look at the strategic fit and then the people that you are going to be partnering with and working with both the operators as well as the, as well as the finance partners, and really do a double check there. Does it fit the bill from a strategic perspective? And does it feel right from a people perspective? And if both of those, are you check the box on both of those? Then it's worth looking at and it's really worth getting into dialogue about their plans where they are at it, you know, towards the finish line of their goals, how long does it take? You know, do they intend to take… what is their capital reserves? And then, you know, obviously it gets into all of the specifics related to the deal making. And so, you know, these are very good opportunities often say to our clients. It's never a bad idea to explore opportunities with smart money.
30:46 | Ryan
Yeah, it's really well said, Mike, that's all the questions I had today, matt, Mike, I'll turn it back to you for any closing thoughts or questions.
30:56 | Matt
Great topic. Ryan, really glad that we were able to cover it and, you know, as we always say, whether it's us or anybody else, get with an advisor, get with an advisor early as you are considering a new chapter for yourself, and your company, Mike.
31:19 | Mike
Yeah. With that, I guess we'll tie a ribbon on it for this week's. Shoot the Moon podcast. I encourage you to tune in next time we'll unpack further topics of M&A and growth for your IT services companies. You need to learn more about M&A, feel free to visit us on our website at revenuerocket.com. If you have any questions you'd like us to address on this podcast, shoot us a note at info@revenuerocket.com, and we will bring it up. So, with that, take care and make it a great week.