Acquisitions Anonymous - #1 for business buying, selling and operating - Strategies for shopping your financing, and a 15 year old MSP in Kansas - Acquisitions Anonymous 232

Episode Date: September 29, 2023

In this episode, Bill (@BillDA) and Heather (@EndresenHeather) discuss potentially acquiring a Kansas-based Managed Service Provider (MSP) business. They highlight the importance of understanding the niche or specialization of an MSP, which can significantly affect its success and sustainability. They also caution against overvaluing businesses based on the seller's discretionary earnings (SDE) and stress the need to align buyer and seller motivations regarding pricing. Additionally, they address the challenges of retaining customer relationships when key employees have been with the business for an extended period and suggest the importance of meeting employees before closing the deal.Thanks to this week's sponsors!Employer Flexible will help you take action to streamline your company’s HR processes. They  are the proud provider of flexible and adaptable PEO services. If you’re a small business trying to grow, and you’re struggling with a lack of internal HR or you’re just dissatisfied with your current HR setup, consider Employer Flexible as your next vendor for HR outsourcing services.Check them out at https://www.employerflexible.com/.------------------CloudBookkeeping offers adaptable solutions to businesses that want to focus on growth with a “client service first” approach. They offer a full suite of accounting services, including sophisticated reporting, QuickBooks software solutions, and full-service payroll options.Subscribe to weekly our Newsletter and get curated deals in your inboxAdvertise with us by clicking here Do you love Acquanon and want to see our smiling faces? Subscribe to our Youtube channel. Do you enjoy our content? Rate our show! Follow us on Twitter @acquanon Learnings about small business acquisitions and operations. For inquiries or suggestions, email us at [e-mail]

Welcome to Acquisitions Anonymous. I'm Heather Anderson, and today Bill and I got together and talked about one of my favorite industries, managed service providers. It is kind of a small one. We got into, you know, what makes a good MSP versus not, how old they generally are, what kinds of folks generally are selling them. It was a pretty good discussion. So hopefully you'll enjoy it as well. Thanks for joining us. Today's sponsor is Employer Flexible. And what Employer Flexible is, What what flexible does is really function as a fractional HR department for your company or business. I've used them numerous times and putting together my companies. I've used them when I've bought companies.

I've used them when I started from scratch. And basically, when you're moving quickly or when you don't want to spend the time putting together your own HR department, benefits, all that kind of stuff. And you want to get the scale of being part of a larger group. You can reach out to employer flexible. And what employer flexible does is give you that buying power as if you're part of a bigger group and all that kind of stuff. And for me, I love working with them for numerous reasons.

One is I know the owners and a lot of the staff and they've always treated me super good. And then the second thing is I hate HR. Like I don't enjoy it at all. And this way I can know it gets done right. I get the benefits of having a big fully staffed HR department and the flexibility of having a vendor like Employer Flexible being there as a partner throughout my journey

and making sure that everybody I work with is happy, taking care of, and we can focus on what really matters in our business, which is take care of our customers. So you can find their contact details, locations of their various offices, as well as more details on how they will help your business by going to employerflexible.com.

And again, that's employerflexible.com, and thanks to them for sponsoring today's episode. Hey, Bill, good to see you. Yes, good to be back. Yeah. Yeah. So what are we going to look at today? What are we going to talk about today? Well, before we get started, I just, I came in hot from something else. And I don't know, we were talking a little before we got on. Like some of these, you know, like I prep for an hour

before. And then sometimes I'll like hop out of another meeting. And it's like, boom, recording acquisitions anonymous. So I am making the transition today. Okay. You get your head in the game. I told you, Bill. I didn't schedule anything an hour before this so I wouldn't be like that because that's hard for me sometimes to switch from whatever it is I'm doing to, you know, looking at this deal. I look at a lot of deals. That's the other thing that goes on in my brain is I look at so many deals with my clients that sometimes I get them, you know, the details of them intermixed in my head. And wait, wait, no, that's not that one. That's this one. So I got to have my focus.

How many new, new to you deals would you say you see every week? I probably see, well, about five under LOI, so that I'll spend the most time on those. But I will also look at a lot of pre-L-O-I, so I'd say probably another five or six pre-L-O-I. So at least 10 every week. And so, yes, you can see where they kind of start to merge together. If they're similar, they have some little quirk about them that's unique or similar to something else. But it's a lot of deals, lots. Yeah.

Do people usually come to you and Vizzo, like, with an LOI or pre-L-I? I invite them to do both. So obviously, I really want them to call me. I want them to make me the first call when they have assigned L-I so that I can, I don't want them to go to different banks and me. I want me to do all the bank shopping for them. But as a service, I look at pre-L-OI to help them sort of figure out what's bankable.

It's really hard to submit an LOI if you're not sure you can get financing. And I think, you know, the current environment has made that even more difficult. banks are, you know, credit is tighter, period. And so it's just a good idea to kind of preview before you submit the LOI, make sure there's nothing that's not financeable in what you're offering. So I do that too. I see that an awful lot where people will make an offer to a seller. They'll get all fired up.

They're like, okay, I like this deal. I'm making an offer to a seller. They'll write an LOI. And then they'll go, okay, now I've got to get it. financed, right? And they'll go to get a finance. And it's like, dude, like, you have no chance. Like, this doesn't work, unless you have all equity, you're not going to be able to do this. And then the buyer ends up in this really awkward position where they got to go like back to the seller and go, actually, I'm a moron. I can't pay you that. And now the seller's all bummed out

because they had gotten excited. And it just, it really puts you in a really bad spot at the very beginning in your process. Absolutely. It is absolutely the best practice is to make sure it's financeable first. And I think that's what's unique about VISA. I can tell you out of, you know, 15 banks, is it financeable? If you just go to one bank at a time, one bank might say yes, another bank might say no. And that variance between what banks like and don't like has gotten more pronounced in the last year and especially I would say the last six months as rates have increased and banks have just gotten tighter for a variety of reasons, you know, kind of specific to banks. That is always really surprised me because you think people tend to think of banks as a

commodity, right? Like they're selling money and you just kind of compete based on rate like whoever wants to sell money at the lowest price. But it's blown me away. So we're in market right now for a asset backed refinance, which I talked to you about. And we have talked to some people and they're like, like told them the exact same facts, exact same everything. And some banks are like, hell yeah, we want that credit. Some banks are like, that's disgusting. Don't ever call me again. But you said it in your own way. Yeah, it is, it is exactly like that. Some will, what, you know, one man's trash is another man's treasure that is actually happening in banking even more pronounced now than it ever has been. But yeah, the credit appetites are all very, very different. Really

depends on a lot of things that are going on within a bank, not just on the loan side, but on their deposit side, whether they're trying to grow, if they favor a particular industry. And honestly, I tell people all the time, if even just one person in that bank got burned on a deal before, and it could be a long time ago, if your deal has any, it reminds them of that situation in any way, shape, or form, that bank is out for you. And that's just the way it is. ridiculous. It's so true. And I run into it in e-commerce, right? So, like, we sell dog supplements. We're branded. We make our own dog supplements. I have run into lenders that, like, in 2015, like, did a bad deal on, like, a, like, you know, I don't know, chairs.com that sold a bunch of chairs under everyone

else's brand. And I'm like, that is not the same. Like, just because this is e-commerce, like, you can't paint this whole thing as e-commerce. Like, these guys were drop-shipping heavy chairs in 2015, and we're probably idiots. Like, we're selling high-margin branded dog supplements in 2023. Like, this is not the same. And it doesn't matter what you say. Like, they're out. They're just, they never can do it again.

That's right. Exactly. It's just, you fell into a bucket that reminded them of that chair thing, and that's it. It's over that the conversation has ended. So, yeah, it is really, really interesting. And not really, like, the smartest way. way to make credit decisions, but, you know, I always say banks are just people, too. It's not like there's this great, you know, they're just, they're businesses with a bunch of people and those

people are all trying to do the best they can, make decisions, but they're people, they're flawed. Banks are people too. That should be your catchphrase. I'm the only one said that. Yeah. Banks are made of people too. It's true. So, I mean, I think, I think the big listen for me is like you run in these lenders and like tons of them will reject you for stupid reasons like because they dated a redheaded girl once and you're red, you look redheaded and they don't want anything to do with it because they got bad memories. They'll reject you for that reason. They'll reject you because, oh, we already have too much exposure to your industry in our book.

We don't want anymore. And you're like, well, that's not fair. You're telling me you like it, but you just don't, you can't have any more of it. And they're like, sorry. Or, you know, there's all these bank idiosyncratic reasons where people want to want your credit. And so my experience has been you just got to go wide when borrowing. And that's what I try to do for my clients. I go wide, but I also, I'm talking to 15 banks every week about what I'm working on. And so I have a little bit better, you know, my fingers

are on the pulse of what they currently like. And I mean, it's current. Like one bank, the next week might say, no, no more of that now. Where last week it was good. So, yeah, that is how, that is the reason I exist as a business. crazy. Yeah, it's valuable. Okay, well, so much for the unsponsored viso pose. I'm going to send you a bill for that. Thank you. But, all right, we've got a deal. Would you like me to get into it? Yeah, please. All right, because you're technically the host, so I have to ask your permission. Oh, I grant you that permission. All right, very good. Okay, let's, let me share this out for our people watching us on YouTube. Plug to watch us on YouTube, by the way, you get to see our ugly mugs

and our crazy facial expressions. So this one's cool because this is an industry that's been hot lately. It is a Kansas MSP managed service provider with strong recurring revenue. It has revenue of about a million bucks. It has EBITDA of $120,000 and cash flow of $242,000, which is interesting. It's been around since 2008, so 15 years old. They've got $50,000 of furniture fixtures and equipment, and they're asking $728,000 exactly, which is, I guess, roughly three times, right? Seven, 28. Well, six times EBITDA, if you count that. Six times EBITDA, exactly, literally 3.008 times cash flow. So I wonder how they came up with that. Okay. So it is an excellent managed service provider in Overland Park, Kansas.

It has strong contractually recurring revenue. They're projecting $750,000 of recurring revenue for 2023. So that tells me about 75% of revenue is contractually recurring. It also says 98% of revenue is derived from commercial clients and company is standard systems for managing client relationships and service. The team includes three IT support technicians and a service coordinator. two of whom have been with the company since before the current seller acquired the company in 2008. So that's interesting. This guy bought it in 2008, and it's been around since even before that with some of the same team.

The IT specialists have varying levels of expertise from high-level architecture and network security to hardware installation and troubleshooting. They have optimized their service offerings to best serve their client needs while aligning with company profitability, blah, blah, blah. It maintains a well-situated storefront with science. prominently displaying services, an operator interested in shifting to a work-from-home environment could further reduce fixed expenses. I love how they talk out of both sides of their mouth. They're like, the signage is fantastic in a prominent location,

but also you could save a bunch of money if you bailed on all that. Yeah. Right. That is the most classic broker sentence maybe I've ever read. Yeah, I think so. It's for-employment. Yeah, I think the rest of this stuff is mostly, is broker BS.

With your vision and strategic direction, you can unlock even greater value and take it to new heights. The possibilities are limitless. And it says the seller will stick around for a little bit because he cares deeply and will help you out. It's an Overland Park, Kansas for employees.

The location with signage is 2,000 square feet. And there's some opportunities to extend the lease. Apparently, if you think this is really important to you. And that's all we got. Reason for selling retirement. What do you think, Heather? Well, I do generally like MSPs, and I have lent on a few.

I have a few clients and I keep in touch with them. It can be a great space. I'm not too excited about this one. This one has, it's got some good. Heather, you're on the pod for like two months and you catch Greigliitis where you just poop on it at the very beginning. I shouldn't have started that way. There are things I do like. I do like, let's go there, let's be positive.

I do like 75% contractually recurring revenue. For example, a good MSP has about 50% to 60% contracts. So this one has 75, that's above the average, you know, that's above a good one. So it's kind of in the higher tier there. There's even a trade association, and I'm going to forget the name because they actually changed it. But there's a trade association for MSPs, and they actually have something called an operational maturity score. And this is one of the factors in their score, of course, is what percentage of revenue is contracts. Now, usually in MSP, the contracts are only one year. So they're not like

their long-term contracts, but at least they've gotten to a point where their clients are willing to sign on with them for a year. You know, it's probably, this business is probably serving small, small businesses as sort of their outsourced IT, there are many flavors of MSP and the best ones kind of focus on a particular niche. So if it's just kind of generic small business MSP, that's not so great. There's kind of low barriers to entry that you really don't have a moat and it would be easy for you to lose those contracts upon renewal to somebody else for better pricing or some other kind of service. So you'd really want to know with this one, do they have a niche or is their niche just serving small businesses? I would think if they had one, it would have been highlighted here.

But, you know, broker might have missed that. And is it important to have a niche? Why? Because if you're generic, anybody can compete with you? I would think in some ways generic is a little bit more diversified. Like if you're doing health care and health care craps the bed, you're in trouble. How do you think about that? It's double-sided for sure. Like there are risks to being niche and there are, there are positives about it. So niche doesn't necessarily mean you're focusing on an industry with MSPs. I've seen them where they focus on a particular product or a telephone system or a particular software, which that is risky too, right? That's software. We've looked at some before

where we said no, because if this, you know, software changes so rapidly in the cycle of, you know, innovation there is just so rapid, you'd be afraid that that becomes obsolete too quickly. So yes, there's good and bad news to the to the niche side of it. But I think if you're just a generic providing kind of basic services to small businesses, there's just not much of a moat and there's bigger companies that could come along and take away your customers. Either that or you're not going to get the best customers. You're going to get the lower quality customers that kind of fall out of those bigger operations. So I prefer some kind of niche as opposed to none.

And you kind of need the niche also to know whether you can grow. grow this. And if I have a buyer rather than a lender, I'm thinking, what are my opportunities to grow? It's been there for a long time. That's really, this is really an old one, actually. Bought it in 2008. So I wonder when it was founded, that that's older than most that I see. Most that I see are about 14. Yeah, I guess this is about right, but we don't know how old before 2008. They're about 14 years old usually. And most of the time, the ones that I'm seeing, the sellers aren't really the retirement age that you tend to think of. They're a little bit younger, but they're super burned out.

And that tells you something too. Because they're super burned out because technology cycles are so rapid. And it takes a lot to keep up with them and run a business like this. So they can be really good companies, but it's a lot of work. All right. Taking a quick pause here. I have something to tell you. This is Michael.

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Call Charlie, cloudbookkeeping.com. Tell them we sent you. they're a great way if you're a business buyer, if you're a business owner, you're tired of hassling with getting your bookkeeping done. He's got a whole fleet of people that are well-trained and work for him. He's located here in St. Antonio,

so I can tell you because of that, he's awesome. And they're a great partner for you to potentially call to help with all your bookkeeping needs so you can do the important stuff in your business rather than worry about getting your books right. So give Charlie a call, cloudbookkeeping.com, and now back to the episode. Yeah, because I guess a lot, not a lot of, you know, 50-year-olds are starting MSPs running them for 15 years until they're 65 and wanting to retire.

Right? So a lot of times, retire is code for I'm 45 and I'm fried. Yeah. In this industry, you see it much more often or I'm going to go do something else. A lot of times it'll be technology related. Like, I have a kind of a pet project in technology that I want to go develop this software or something. but they'll be like in their late 40s or early 50s and just tired, you know. So the interesting thing, there is sort of a roll up play going on in this industry where,

you know, if you can get to a certain size, the multiples are much, much better. But it's a lot of work to get to that size. And there's potentially there's some CAPEX here, depending on how you do things. Some companies, they make their customers buy the servers. and the various types of hardware that the business needs to run on. And I've seen some where they buy the servers and charge them out at a premium to their customers.

So whenever I look at MSP, I kind of want to know which one they are. You know, are you buying the servers and owning them? That's a different game, maybe a little more risky. It can be more profitable too, but it can be more risky.

And I had someone, I asked a Q of E provider once, who had done a lot of these, and I said, and they actually owned one too with, they were a part owner in one. I said, what's the, like, the number one thing that you, you kind of catch in there. And he said, you know, if you ask them for an equipment list and with locations and they can't tell you where all the equipment is, then that's a red flag. Oh, yeah.

Like he just knew where they, they didn't know what everything is. If you're the business of managing assets, you need good asset management software. Well, yes. And I think that's the thing with a lot of businesses that they don't, maybe consider themselves in the business of asset management. And then they end up having a bunch of equipment assets and they don't have the management behind it. So anyway, I thought that was an interesting little tidbit is if they do own a bunch of servers,

where are they all? One thing I noticed about this one is it's got four people, right? So it's not a big business from a human capital point of view. But most of these guys have been there for 15 years. Now, talk about retirement age, right? Like, this is really good and really bad, right? You've probably got some really long tenure clients who have been used to have in their same IT guy for 15 years. When that IT guy retires, right, they probably got more loyalty to Joe than they do to the MSP.

So if Joe leaves, you're going to probably have, like, you've got a business existential thing going on here that you've got to transition Joe's relationship to some new IT guy. Because there's probably not a lot of loyalty to your brand name. it's probably loyalty to Joe. So you're going to, you got churn risk there, right? Yeah, I think you're probably right. And it goes to a question that I ask in any kind of service business, who owns the customer relationships? A lot of times it is the employees.

And it's one of those questions that, like, you know, the sellers are probably going to tell you. It's them. It's the seller. Or maybe a GM or something. But sometimes it's worth a few more questions around that. And I have seen a deal that actually fell apart after close because the employees owned the relationship. A competitor hired those employees and brought all the customers with them.

And of course, the employees were not under a non-compete. And that's like your worst case scenario. But it does once in a while happen that way. Yeah. Yeah. I just like it's just it's this double-edged sword. Like, yeah, these guys have been there forever. So like you come in and they were there 14 years ago when new guy came in.

they might go, I'm done with this. Like another guy who doesn't know Jack, I've been here for 1,700 years and know everything. You know, like, you just might have a problem. Like, I would want to meet all those people before buying this business. Not on the first day after close. Hi, I'm your new boss. I think that's true with a lot of businesses that you should be able to meet the employees

before you close. And I have seen some of my buyers walk away because the seller refused. Just on that point alone, everything else looked good. If you're refusing that, this is not the deal for me. I think that's smart. I want to meet. It's touching, though, right? I mean, because before you close, you can still walk, right?

And if you bring buyer in to meet all of your employees, and like, that's when you have to tell them I'm thinking about selling the company, right? Or I am selling a company. And usually you don't want to do that until the money is in the bank and the ink is dry and then it becomes buyer's risk. but like, I mean, that's the type of news, by the way, that spreads like wildfire through the rumor mill of a company, right? Like, even if you only have them meet with two key employees, the odds that that gets out are near 100%. Yeah, I hear you. And it's very true. Like, some sellers are going to play it very close to the best trying to protect the fact that they're trying to sell the business. I subscribe to this notion that there are no

secrets in any business. Even when you think that you are keeping it a secret, somebody knows, you know, somebody that's helping you put the documents together for diligence or, you know, talking to your lawyer or whoever is assisting you with this or the broker. So I kind of go with the everybody knows anyway, like most likely. You think in a small business, like in this one, there's five people. Owner decides to sell it. You think people's still going to figure it out?

Yeah. Yeah, I do. By reading it on Bid by Sell and listening to our podcast. Yeah, absolutely. You know, even this alone, yeah, the fact that it has to be listed and everything else, I just think that, you know, the reality is, and also if it is truly because of retirement, I don't believe the seller never said anything to his employees about retirement ever, or that they never, you know, they didn't look at their age or anything else and kind of suspect that that was.

So I don't know. I just give people more credit. You know, they probably already kind of know. And it's better to at that point when you think you have a good buyer, try to make it all work for everybody than to hide it. Because I have seen sellers just kind of blow the whole deal over this like really extreme secrecy to the point of, you know, it kind of blew up the deal. There just comes a point where you kind of have to trust that people will get this done.

But that's me. I'm not a sell. Let's come back to this deal and valuation here. So they're asking for its MSP, high level of contractual recurring revenue. It's not that big, $242,000 of cash flow. They want 3x. In your experience, is that in the ballpark for an MSP? Is it high?

Is it low? Well, when you say 3X, that's 3X cash flow, which I'm saying probably is SDE. They're adding back like only $120,000 salary. You need that $120,000. to live off of if you're buying this, you're going to run it. So again, I've said this before, and I think I got in trouble with Michael

for saying, I don't like SDE. I don't like pricing off of SDE. The smaller the business, the less I like it. So, Bada, 120, it's six times. No, it is not worth six times. It's way too, this is probably this price is set by this seller's expectations for retirement funds, you know, rather than reality.

And this contractual recurring revenue, this is not like software subscriptions with super high margins. This has still got a lot of costs behind those contracts. So, and again, I would suspect, from what I know, they're one-year contracts. So it's not like you should price it that way, like you would software or something else.

So this is probably three times the 120. This is a 360. This is overpriced by double. Yes. Yeah. Yeah. I honestly, I agree. I'm on team Heather for SD.

I think SDE, small business acquisitions, I have two things that I think are totally whack about small business acquisitions. One of them is SDE. The other one is plus inventory for inventory-based businesses where like working capital is not a thing. And I've definitely done that rant on this podcast before about how it totally missed. disillines incentives, you know, it, it's just totally whack. You know, I've seen businesses that are for sale for a million dollars and they have a million dollars of inventory and it's like, psych, it's two million dollars and now it's eight times or something and it doesn't make any sense. So this is tough and I think you're probably right. You've got 120K of actual free cash flow

and then you got $120,000 of owner's salary, which gets you to EBITDA or to SD or whatever. And that's what they're trying to value on. Yeah. That being said, that's the way the cookie crumbles in this market a lot of times, right? Yeah. I think if you went to this broker and you were like $300,000, he would say, sorry, not interested. Right. Probably.

Well, I don't know how long this has been out there, but yeah, that's all this is worth. It's not worth more than that, and I don't think they'll get that. My other little rant about SDE is why would you pay three times or four times or anything, a salary for a job? Would you do that? Would you pay four times a salary? salary and go take a job and work for four years for free? No.

Right, right. You know, right. Great point. And on the flip side, so amen, but also on the flip side, why would you sell for an EBITDA number? So like, let's take this business, right? Like, this guy is making SDE $242,000 a year, right? If you value it a three times EBITDA, you would pay $360,000 for this business, which he will make in 18 months just running this business.

Right? So like this, this sort of illustrates like the Gulf in small business acquisitions is that it's very hard to find a price that is enough, it is low enough for a buyer and also high enough to motivate a seller. Because this, especially in this SD to EBITDAG gap gets really big on smaller businesses, this guy's just better off going to the beach for 18 months and hoping the business

doesn't collapse, right? Right, but he probably can't go to the beach is my thought on this kind of business. He's working for that $120,000 and he probably is selling just because he wants to go to the beach. And he can't. Yeah, I just, if I'm the seller on this one and the best offer I've got is the 16 months of salary or something, I'm throwing a Hail Mary. I'm going, Joe, you're in charge. I'm increasing your salary, $125,000 a year. I'll see you guys in 16 months if the building's not on fire.

Like, that's probably the Hail Mary I'm throwing if I'm the seller in my best offers 300K. Yeah. Yeah. Yeah. Okay. Fair enough. It's tough. Yeah.

All right. Anything else on this one? Nope. I'm not buying it. Are you? It's just too small. It's too small. And the SDE EBITDA thing.

I mean, otherwise, like MSP with high contracted revenue, not terrible. Yeah. Right? I just this one has some warts on it that are tough for me. Yep, agree. All right. We'll wrap this one up. Thanks for tuning in.

We'll see you guys on the next episode of Acquisitions Anonymous.