Selling Your MSP
I had the pleasure this week of interviewing Randy Katz, co-founder at Synesis Advisors, a boutique consulting firm that helps small business owners sell their business. Today we specifically focused the conversation on MSP’s (Managed Service Providers) and how they can best prepare to sell if that is something in their future. MSP’s are also known as outsourced IT services firms and they typically help their clients manage workstations, applications, security and other infrastructure. MSP’s is a big market (estimated at over 40,000 according to ConnectWise), that is highly fragmented, which creates a great opportunity for companies to be buyers or sellers. Here are my six key takeaways from Randy, but listen to the podcast to learn more:
- Do you want to be a deal maker or deal taker?
I loved this comment from Randy. What he challenged us to think about was how proactive the business owner wants to be in preparing his company to maximize value. If you are reactive and hurried, you’re going to be a deal taker.
- When you have one buyer, you don’t have them. They have you.
Randy’s point here is that even if you think you know who your buyer is going to be, there is risk of not having an alternative. This is where Synesis can help significantly.
- Know your time horizon.
Are you aiming to exit in one year or three years? Your timing will impact the amount of preparation you can reasonably undertake to position the company to maximize value.
- Know what type of buyer you are looking for.
If you want to sell to a private equity buyer vs. a strategic buyer vs. an individual buyer, that will dictate how you position the company for sale. A private equity buyer will want to buy the ongoing management team in most cases. An individual buyer won’t. What’s important to you.
- Frame the narrative. Stay in control of the process.
This is another good reason to have an advisor but the point is that if you give the interested buyer all your information but don’t ask what they are looking for specifically, you will stay reactive in the process.
Okay, I don’t want to give away all the goodness from this episode so make sure to listen to it. You will walk away with a lot to think about and most importantly, a lot to take action on, if selling your business is something you are interested in pursuing over the next several years.
Who should I interview next? Please let me know by clicking here.
In this Podcast episode with Randy, you will learn:
- How to maximize value by being a proactive deal maker.
- Why having only one buyer puts you at a deficit.
- How to identify your time horizon.
- The importance of identifying the type of buyer you’re targeting.
- How to get in control of framing the narrative.
We are fortunate to have Randy available to spend time with us on this edition of Stride 2 Freedom. If there is a speaker you’d like us to interview, click here and let us know. Stay well. Stay safe. Stay healthy.
Show Notes and Links From Episode:
Randy Katz LinkedIn
Randy Katz Email
Russell Benaroya: Hey, everyone. Welcome to the Stride 2 Freedom podcast. My name is Russell Benaroya, and I’m the co-founder of Stride Services, a virtual back office, bookkeeping, and accounting firm serving hundreds of clients around the United States. This podcast is designed to help small business owners focus on growth and innovation. In other words, focus on those things that inspired you to start your business in the first place. We call it your genius zone. We do our job on this podcast when business owners feel like they have the trust and confidence to build the right team of partners around them that will help them grow. Thanks for joining. Let’s go.
Hey, everyone. Welcome back to another episode of the Stride 2 Freedom podcast where we help business owners and business leaders get and stay in their genius zone. What is your genius zone? Your genius zone is your superpower. It’s what you do that feels effortless. It’s what you do where people wonder, “Oh my gosh, how did you do that? I didn’t know you were so capable.” And you’re like, “I don’t know. It’s just what I do.” If we can keep business owners focused on their zone of genius, we know that they can create outsized impact.
My name is Russell Benaroya, and I am your host today on the podcast. The podcast is brought to you by Stride Services. Stride Services is an outsourced back office, bookkeeping, and accounting firm serving MSPs, agencies, and general consulting firms. Our superpower or our genius zone is helping embed data into business owners’ decision-making by giving them financial information to be more informed in the decisions they make to drive their future forward. I am excited today to welcome our guest to the show, Randy Katz. Randy, how’s it going?
Randy Katz: Good afternoon. It’s going well. Thank you for having me.
Russell Benaroya: Nice to see you. Randy is the co-founder of Synesis Advisors. Synesis is a firm that specializes in helping small, mid-sized businesses navigate the purchase or sale of their business. I would think of Randy and his partner Matt Cohen as guides. These two are great guides in helping business owners manage the invariable roller coaster that’s associated with either acquiring a business or selling their business.
What I’ve enjoyed about Randy, and I think what you’ll enjoy as well, is this is one straight-shooting guide. He tells you how it is. The reason why he’s so effective at that is that Randy achieves his value or earns his value when a transaction is successful when it’s completed. So he’s going to be very candid around whether or not there’s a likely opportunity before you which is super cool. Is that right, Randy? How’d I captured that one?
Randy Katz: No, I think that’s great. I think it’s great. There are many people who do what I do and even just in general that tell business owners or their prospects depending upon what industry they’re selling into they tell the party what they want to hear. Whereas when you’re making big life decisions, it’s more important to educate the owner about what they need to know. Sometimes it’s not going to be what they want to hear, and they’re going to have to make really difficult decisions. And it might be stressful and frustrating. But in our world, that’s going to lead to just far more effective clients, better deals even if it means it takes longer to achieve it. So, no, you said it right. Hopefully, that candor comes off as we’re going to the discussion.
Russell Benaroya: I’m sure it will. I asked you today to come to the table with a particular focus, and today we’re going to have a specific discussion around engaging MSPs or managed service providers. MSPs, again, or managed service providers for those of you that aren’t familiar with the acronym are often referred to as outsourced IT services firms. So these are companies that are helping other companies manage their infrastructure, their security, their applications, their network. There are a lot of them in the United States. It’s estimated there are about 40,000 MSPs.
The reason that I wanted Randy on the show to talk specifically to MSPs is not that the content that we’re going to be talking about today is just for MSPs. But it is really for any industry or business owner in an industry where there’s a lot of fragmentation, where there are a lot of companies that are in that one to $10 million in revenue range. And you have a lot of business owners that are wondering how are they going to rise above to create the equity value for their business in pursuit of the dreams that they have set for the life that they have wanted to create?
I just think that talking specifically about MSPs is, one, fun to talk about a particular customer segment. But two, I think MSPs are actually representative of a lot of fragmented industries for which Synesis Advisors has value and application. Without further ado, with that crazy long intro, Randy, set the stage for us a little bit about how Synesis gets invited to or comes to the table to work with buyers or sellers on potential opportunities.
Randy Katz: Sure. As you stated, our core business is in selling businesses. And of course, the corollary of every seller is there’s a buyer, so we do buy-side representation as well. But when we’re talking about preparation, we’re usually talking about a sale. When you’re talking about a deal, you have to recognize the big scope of work that we might be involved in. So that’s helping business owners understand, “What is my business likely worth?” That’s not just price, but that’s also deal structuring. Am I getting all the cash at close? Am I likely to carry a promissory note? Is my compensation going to be tied to future performance of the business in the form of an earnout?
Of course, when you think about that, that’s the supply side of…Or excuse me, that’s the demand side of the equation. What’s a buyer likely to pay? If a business owner is not willing to supply the business at those likely prices, you’re never going to have the lions crossed. You’re never going to have a deal. So it’s always going to start with helping owners understand, “How’s the market going to look at my business, and am I even in a ballpark of a range that I consider a sale?” Of course, if the answer is no, they’re not going to proceed through the rest of the process.
But as we think about the rest of the process, we would be involved in helping the owners put together the offering memorandum. What does a buyer need to know about the business to evaluate a 30,000-foot level? So information about the history of the business, the client base, our team, the financials of the business, what our contracts might look like whether it’s customer contracts or other obligations we may have in terms of capital leases, physical leases for our space, and other operating leases.
Finding buyers or putting together the go-to-market strategy, who is our type of buyer? How do we find them? When we have identified the buyers, identifying the best way to facilitate the flow of information through the offering memorandum, through Q&A, through data rooms, at what stage can they go from the 30,000-foot level to the 15,000-foot level to the end of the weeds during what we might think of as due diligence? Managing the diligence process, and then having your project management.
When we think about deals, there may be 15 people involved. And this brings us back to the beginning of your question, Russell, which is how do we get involved? But in the project management stage, there might be attorneys on both sides. There might be CPAs on both sides. The buyer or the seller might be consulting their financial advisors to look at on the sell side, “How much am I going to end up after paying taxes, and is this giving me enough money to live the rest of my life?” So that might be a financial advisor conversation.
On the buyer side, they might be looking at the return on assets, return on equity, return on their investment overall. And then, of course, going down the line there might be capital raises. There might be banks involved, escrow agents involved. There might be lease negotiations for an assignment of the lease or maybe it’s new leases that we’re looking for new option periods. Maybe there are commercial agents involved in that.
We’re involved in the big picture from, “I’m thinking about selling.” to actual project management through the effectuation of the deal. And as we talk about those various parties that are professional constituents to the deal, all of those are, call it, buying referral sources in and out. So very often the owner is talking to one of those parties about something that might be related to a deal or something related outside of a deal.
Either the owner mentions they’re looking to sell or maybe that party is sharp and recognizes, “This could impact the decision down the line. Let’s talk to Randy to figure out, how does this impact a deal or how does this impact other parts of a deal if you’re not thinking about it?” And then they’re bringing me in to have these discussions with the owner. It might be, “I’m thinking about selling my business now.” Or it might be, “How does this impact my deal two, three, five, 10 years from now so that I don’t make a decision that negatively impacts each of those other constituents once they come into the deal?” So any one of those parties could be a referral source that then says, “Hey, Randy. How does this play into the owner’s needs?”
Russell Benaroya: Randy, I know you have some experience in guiding with and transacting on behalf of MSPs. What are you observing in the M&A market today or have you observed in the recent past in the M&A market for MSPs? What’s going on out in the marketplace that it’s not so opaque that you can see it a little bit?
Randy Katz: Sure. Let’s talk just about the general market, and then we’ll talk MSPs specifically. The way that I see this market, it’s pretty well-bifurcated. You got those businesses that were negatively impacted by COVID and have not yet rebounded. Those deals are very, very difficult to get done. There may very well be a huge supply of inventory for those deals. But the buy-side marketplace isn’t interested in those deals unless, of course, you’re a distressed asset investor.
But it’s much more difficult to find pricing that the seller would accept. It’s much more difficult to find deal structures that the owner would accept. It’s much more difficult to raise capital in those deals. Then, of course, there may be working capital needed to see it rebound. And so it’s not just buying the business but investing into it to get it to rebound. And so those deals are very, very difficult. I would say a high percentage of them aren’t getting done if the owner does attempt to take it to market.
The other side of the marketplace are those businesses that have either not been impacted by COVID or they’ve rebounded and it’s very easy to see the rebound. So when I’m looking at those businesses, even if 2020 was terrible, I’ll look at a monthly P&L and look at the trends in 2021 and compare it on a month over month basis relative to 2019. You can very clearly see the recovery trend and how they’re on pace. If you see that they’ve turned the corner and you’re seeing now achieving 2018 levels and above, it falls into this other bucket.
Those businesses that are doing well, it is a very, very hot marketplace. Not enough inventory of good businesses to be sold yet a huge number of buyers. Banks are flush with cash and want to lend. Buyers are flush with cash, have nowhere to put the capital and there are not enough opportunities. So when you have those businesses that are doing well and businesses that have reason to exist, it’s very much a seller’s market for those businesses.
Take MSPs. You have an industry where you’ve got a recurring revenue model, and buyers love recurring revenue models. Think of not just the ongoing need but the trend of what’s occurring with more people working remotely which means now more endpoints that are going to need to be managed. You’ve got changing technology. So different security needs, upgrades in hardware, upgrades in software. And so more people need their support.
You have an industry that’s hitting all the right notes that’s very hot from a fire marketplace. So it’s a marketplace that if a business is priced correctly, and that’s the key point here. If you price a business correctly and give it enough time and structure, you’re very likely going to sell that business. And a very hot market in general. For those businesses that survive and MSPs in particular, it’s been a very hot marketplace.
Russell Benaroya: If you’re listening to this podcast and you’re an MSP owner and thinking to yourself, “Hey, I’ve been thinking about how I’m going to exit my business because I maybe want to do other things in my life or I feel like I’ve been at this a long time or I’ve built the business to a level where I’m ready to move on.” It’s one thing to have that notion, it’s another thing to set your business up to be received well by the buyer marketplace. What are those things that business owners should be thinking about in terms of their machine, the business they built, to be ready to be brought to the dance?
Randy Katz: It’s a loaded question. What can I do to businesses…
Russell Benaroya: Yeah, I got some. What can I do to…
Randy Katz: I’ll give an example and why it’s challenging.
Russell Benaroya: Okay.
Randy Katz: Because keep in mind, it always starts with the owner and what are their needs. If an owner says that they’re moving out of state because they have to care for their ailing parents, that business could be sold very quickly if you price it correctly. I’m not saying price a business low, but price it at a level that the market would be receptive, relative to its revenue generation and its earnings, or structure a deal in such a way that it’s very attractive and you can get deals done very quickly.
It’s not just a matter of, “Do these things to get your business sold.” It’s also coming back to the owners’ needs and how they’re willing to price and structure deals. But what you’re getting at with the question is, “What are things I can do to make my business worth more?” It starts with a couple of things. One is identifying who’s the likely type of buyer for my business, and that’s going to be different depending upon your size.
For example, let’s identify the types of buyers first. One buyer might be the individual owner-operator. One buyer might be strategic, they’re already in the industry and want to just buy accounts or want to expand to new geography. You might have a financial buyer like a private equity group or a family office. Each of those buyers has different needs, different levels of sophistication, different access to capital, and they’re looking for different things in a deal.
First is identifying who’s the likely type of buyer because setting up my business for success in a deal might be different if I’m selling to a private equity group that needs my business to have a huge amount of infrastructure in place and wants the management team to stay on to manage the business versus I’m going to sell to somebody who worked at Oracle who has a strong IT background but is going to get an SBA loan to buy themselves a job. And they want the owner to go away within six months because they want to capture all that income for themselves, and they are buying themselves a job.
The things I might do would be different. I think first is identifying who’s the likely buyer for my business, given my size. There are lots of MSPs that are franchise models that might force you into a different type of buyer. Your geography might put you towards a certain type of buyer. The decisions that I might make could be different depending on these types of buyers, and we’ll touch on what some of those could be.
The next one is, what’s my time horizon? For example, if I’m selling in one year, the decisions I make might be different than the decisions I would make if I was selling in four years. Just as a quick and simple example, there might be a business that is at complete capacity and to grow needs to do some function of hiring people, buying technologies, and investing into the business to get over the hump.
But if you do that, the next 20% of growth, you make less money. And of course, maybe the next 30 or 40% of growth could be just to get back to the same level. Well, am I selling in one year or am I selling in five years? Because if I’m selling in one year, I might be better off not making those investments and selling the business and letting the buyer either utilize their infrastructure to make those investments.
If I’m selling in five years, if I can get over the hump and make the investments into the business, then I might be far better off by doing so. This comes back to what’s our time horizon given the decisions that we’re going to make. There’s going to be a wide range of things that we can do. Very often buyers and banks are looking at three years of financials.
This, again, comes back to what are things that I can do. How long is it going to take for various items to show up within my financials whether it’s cleaning up my bookkeeping, whether it’s looking at my pricing and thinking, “Gosh, if I only do price increases once a year or have time to look at my contracts once a year, I might need to look at the cycle over the next 24 months.” Because I can’t go out to my clients all at one time and either A, raise prices or get them under an MSP model from a time and materials model or lock them into a longer-term contract. It might take me two years to do so.
I’m going to need time to go back and talk to all my clients. But I have to have a recognition of what I’m trying to accomplish over that period. So I’ll stop there, and we can peel back the onion further to any one of those if you’d like. Because there’s just so much to unpack when you say what can I do to get ready.
Russell Benaroya: Thank you for parsing this. Time horizon, very important. The type of buyer you’re looking to attract, also very important. And so depending on time horizon and type is going to dictate, well, what are some of the actions that you can take to prepare yourself to maximize value under your circumstance.
Randy Katz: Absolutely.
Russell Benaroya: Did I hear that correctly?
Randy Katz: Absolutely.
Russell Benaroya: Yeah, love it. Great consideration. Somewhat independent maybe, maybe of who that type of buyer is. You’ve probably seen over so many transactions that you’ve been involved with where the buyer tends to get…I’m going to use the word stuck in due diligence where there are these moments in the process where it gets a little uncomfortable for the seller because the buyer uncovers something, and maybe there are some patterns that you’ve seen where they typically find something and then come back and use that as a tool for renegotiation. I’m curious if you could share some of your observations or experiences. Sure. I think some of this will be very relevant to MSPs but maybe just more broadly in small business M&A.
Randy Katz: Sure. Any business owner should ask themselves one particular question before they go to market because this is where a buyer is going to start, which is, “What are the assets that I’m selling?” When we think about an MSP, the biggest assets are going to be my customers and my employees that can service those customers so that effectively it’s an ongoing revenue and earnings stream.
Russell Benaroya: Yeah.
Randy Katz: Of course, there are systems and processes that go with it. But in that business as a service-based company, it’s pretty easy to understand. I get a spread between what I charge the customer and what I pay my people. So those are the big assets. We’re going to come back to the customers and the employees in your question because that’s how we peel back the onion. But every deal always starts with, “How much money can I make?” So the term we’re going to hear is going to be the quality of earnings. Where do buyers get stuck?
Let’s talk about the quality of earnings first. You advertise that this business makes a certain amount of money. So let me first verify, is the business making the money that you say it is? That might sound simple, but let’s say that a business files returns using cash accounting. And they have hundreds of thousands of dollars of AR that they kept in a drawer until January 1st so they didn’t have to pay tax till the following year. Then they cash all those checks.
Well, if they don’t do that the next year, you might then have a lumpiness of cash flow such that it’s not truly representative of the amount of money the business made. There’s always a question, “Okay, is the business operating on cash accounting or accrual accounting? And is it making what you say it is? Are you operating compliantly?” Maybe it is making what you say it is. However, you have all of your employees in California classified as independent contractors. And you’re not paying payroll tax or you’re not properly paying sales tax on what you’re selling.
And so when I operate compliantly, maybe that’s what you made. But I won’t make that money because I didn’t operate in a legal manner. So what’s it going to look like going forward? Quality of earnings also refers to the sources of that revenue. Not all revenue is created equal. For example, with MSPs what’s so attractive about the model is that it’s recurring revenue in nature.
Russell Benaroya: Totally.
Randy Katz: There’s also the project-based revenue which is going to be time and materials, so there’s some portion of it that might be the hourly revenue that I generate. And then, of course, there’s a margin I might get on the sale of hardware or software. Each of those buckets of revenue might be valued differently. When you think, for example, about project-based revenue or sometimes the sale of hardware or even software, you might get these annual bugs because you’re in the middle of an upgrade cycle.
You might have a software provider that stops servicing an old version of the software, and you might get new purchases that are one-time in nature. Buyers are looking at the source of that revenue and their quality of earnings. So very often when you run into those issues of, “Hey, the business isn’t making what they said it was making.” or, “There’s a lower quality of the revenue than we thought.” That’s one big red flag that pops up.
But we talked about that’s often a function of the customer issues because, hey, our customer base is what generates our revenue stream. So they’ll dig into, who are these customers? Are there concentrations of revenue? Are there concentrations within an industry? We know, for example, with COVID there were certain industries that were very negatively impacted whereas others were less impacted. So do we have a diversification of industries that we service, or are we at least servicing industries that are more insulated from external shocks and recessionary environments? Who manages those relationships?
For example, if the owner manages those relationships, there’s a bigger transition risk if the owner is going to go away. This might play into the type of buyer, for example, and what our transition will look like. And is our buyer an individual owner-operator who wants the owner to go away or a strategic buyer who wants them to stay on? What’s the duration of our agreements, and are they assignable? Does the customer pricing fit into our model?
I might be a strategic buyer. But if I find that the customer base, the revenue per se is far lower than we would otherwise charge that then might impact our financial model. Our gross margin is going to be where we want. Are we going to be able to pay our team what we think they should be paid and still get the correct margin? Or are we going to be at greater risk that those customers are going to go away because we need to raise prices to get them within our model?
On the employee side, we talked about how important the owner is. But what about other key employees? Are we at risk of other key employees leaving and potentially taking customers with them? Is there high employee turnover that might translate into our customer churn? Maybe we can look at the new customer growth and what customers have gone away, and we can calibrate that with employee turnover. And we might find that there are some correlations there that we need to think about.
As the buyers are doing diligence, they’re looking at, “How much money can I make?” But that money is a function of the customers and employees, so they’re going to peel back the onions on all three. Those are going to be the three biggest showstoppers you see specifically within service-based businesses and largely to any type of company. But those are the big showstoppers during diligence that lead to deals either dying or getting renegotiated.
Russell Benaroya: Out of curiosity, how do you guide your clients on the sell-side around when and how to communicate with their employees that this business may be sold? I’m just curious. How do you guide the owner to…When is the appropriate time to talk to employees about this? And I know not every employee is created equal because you might have some that are required to stay and might be subject to a new employment agreement. I’m just curious how you guide me.
Randy Katz: This is always a difficult one. Owners are very concerned that if people find out customers, vendors, employees are competitors, then it could be problematic. The concern is always that my customers might decide, “Hey, it’s time to shop for a new party.” What the employee is concerned about is, “Am I going to have a job? Am I going to be compensated the same? Maybe I’ll just look to see what’s out there. And, gosh, I got a job offer. Maybe the devil I know is better than the devil I don’t.” So the challenge is trying to figure out what to tell them.
Generally speaking, those who are key employees where if they leave, it’s going to be detrimental to the business, the buyer is going to probably want some assurance that they’re going to stay. So they’re probably going to be brought into the discussions early on because they’re going to have either an employment agreement or they’re going to perhaps even have an equity arrangement with the new buyer. So that part is probably brought to the conversation early.
Nobody wants to feel as if they’re an afterthought, so bringing them into the discussions before it’s a surprise is probably the right thing to do. Those employees who are not necessarily key employees might be great for the business. But they’re not managing the customer relationship, they’re not generating all of the new business for the client. Those are probably going to be employees that find out once the transaction takes place. It’s probably going to be a discussion at the conclusion of the deal when it’s announced to the rest of the team.
Russell Benaroya: And there’s some risk. Not to the deal, but there’s some risk the employee may feel disenfranchised and may leave. But you’re trying to lead with authenticity and integrity and just share like, “Hey, this is what’s happening.” And, yeah, we gotta put it out there and be honest and see where the truth falls. But…
Randy Katz: There’s absolutely risk, and there is a risk to deals as well. This comes back to preparing for a business with coming back to what is the asset that I’m selling. Is the asset my team? Is the asset my customer? Or is the asset me?
So, for example, if I’m the one doing all the work and I maintain all the relationships, then there’s a far greater risk that the client is going to go away and the ongoing business is going to go away. And that might ultimately change my deal structure. Whereas if I have 25 employees that are level one to level three tax or whatever my service providers are in my industry, the reality is every business has turnover. So it’s always going to have to be managed. And so, yes, there might be risks that there’s more during a transaction period. And, of course, the ultimate employee turnover is going to be a function of what was their relationship before the deal? What was their relationship to the business? What’s the culture of the organization? How are they compensated relative to what they’re going to get in the marketplace?
There’s a lot of things that play into before the deal happens that may increase or decrease the risk of there being transitionary issues, and that’s partly what a buyer is going to dig into during diligence or at least through their Q&A of the owner. And they’re going to be building that transitionary risk into their thinking when they ultimately do make an offer.
Russell Benaroya: I love the question of what is the asset that you’re selling. When you said, “Oh. Well, the asset is you, the seller.” I recoil a little bit to that. The message I want to send out is, don’t hang your hat on that. That is not how you’re going to maximize the most value. Most buyers want to buy a machine that has more predictability that is driven by just a single individual.
If you are building a service business and you’re at the center of your business and you feel like everything around you is in support of you, reconsider the machine that you’re building if you want to maximize equity value. This is my story. Not necessarily a fact, but it is certainly how I think about building Stride. I’m not sure if you would echo that or say, “It depends on the business.”
Randy Katz: Well, no. You stated it perfectly which is if I am the asset in the business, I’m not a business. What I do is I’m self-employed. I have a very high-paying job. But do I have a business? I’m still creating value, but the value is coming to me in the form of perhaps above-market salary. So I may recognize that if I am the asset, the value I capture is along the way every year when I get my salary and then the equity value might be lower. Whereas if I build infrastructure around me, I might make a little bit less on an annual basis. But I have far more equity value in the end.
I need to make sure I’m maximizing value over time considering what do I make on an annual basis through my salary or net income and what do I build on equity value and build my infrastructure and build my business and my thinking around maximizing value over time. So the owner needs to decide which they want to be, and there’s no wrong answer for what they want to be. But in terms of maximizing equity value, you’ve got to build an asset that transcends you as the operator.
Russell Benaroya: Well said. I have a good friend. His name is Jamison West. Jamison is very active in the MSP community. He’s built and sold a couple of MSPs himself, and he is about to publish a book. The book I’ve just reviewed is called The Emotional Side of Selling a Small Business. And it’s a gripping fable, the way he wrote the book of the story of this guy Alex.
Alex is selling his MSP, and it’s a total emotional rollercoaster. There are moments of the exhilaration of the prospect, and then there are moments of fear and guilt. And I’m just curious, Randy. While you may help sellers execute a transaction, I have a belief that you are also the resident psychologist for many of these sellers. I’m curious if you can share some of the emotional management that you do when you work with clients that are going through this process, maybe for the first time or the only time, the biggest deal of their lives?
Randy Katz: It’s funny. I often joke that throughout the deal I’m going to wear many, many hats. It starts with thinking through valuation, what am I worth? And then, of course, it goes into marketing. What needs to be the narrative of this business and the important things that a buyer is going to look at? How do we get in front of those buyers? And then it turns into sales. Great. We’re negotiating a deal, so how do we properly negotiate?
Very often, I’m bringing ideas to the attorneys and the CPAs about, how do we mitigate taxes or how do we structure this? Or what are various things that we might be thinking about in the legal negotiation? But how does that hit other parts of the deal? So you have to have a lot of knowledge about law and tax. And then, of course, I always joke that at some point, I will be your therapist and guide you through that piece.
In our business it’s not usually buyer’s remorse, it’s seller’s remorse. Now if you’re a very large company, and very large is a relative term. But there might be this huge cash-out scenario. But generally speaking, the multiples of earnings or EBITDA or seller’s discretionary earnings, whatever metric we want to use. They’re usually not so large that there are these monster cash-outs.
The owner is going to pay taxes. They’re going to pay fees. And they’re always going to come back to this idea that, “Wait a minute, I can work for a few more years and make the same amount of money. So why would I sell?” And so there always has to be something besides the money that gets them there. If the owner doesn’t know what they’re going to do next, it’s really difficult to let go because the business might be a separate entity but it does become a party.
I think there’s a lot of upfront discussion with the owner about how are you going to spend your time? Are you going to be able to let go? What’s important to you? Not just the dollars, but what else is important to win a deal? Are there certain things about your employees or your team that are important to you that we need to take into consideration? Because they might not have thought about it until you’re through a deal and then it starts becoming more emotionally taxing.
The other one is just education. There are going to be a lot of surprises for an owner throughout a deal. When they find out how much goes to the taxman and a deal, that’s going to be a big surprise. When a buyer makes a deal that includes a promissory note or an earnout, that can be a big surprise. When a buyer is doing diligence, the overwhelming amount of information that gets requested might be a big surprise. All of these things will cause deep emotional reactions on the part of the seller. So how do we deal with that? It’s through education at the beginning of the process.
So it’s important to spend a lot of the upfront time in the deal talking with the owner about their needs and then setting expectations about what’s going to happen at different stages so that they’re prepared when it does occur. Because anytime you have a big surprise that you’re not expecting, you’re going to react. And so the more we can remove those surprises, the more we can remove the emotional issues that would occur.
Russell Benaroya: Speaking of education at the beginning of the process, when would you ideally like prospective clients to reach out to you? When do you want to start having these conversations? What kind of guidance would you give to MSP owners out there around just timing to engage to connect with you?
Randy Katz: Any business owner would be remiss not to have these conversations at least two or three years in advance.
Russell Benaroya: Okay.
Randy Katz: Some, it might make sense five or 10 years in advance. We talk, for example, about buyers are going to look at certainly three years of financials if not five years of financials. So it might take time if a business owner needs to clean things up. Perhaps you handle outsourced accounting needs. If the financial structure of the organization is broken, we might be able to fix it. But we’re not going to be able to see the impact of what’s been fixed until we get to the end of the year.
Well, what happens if we fix it in June? That calendar year doesn’t even show the full impact. So now when we look at the next calendar year, we’re still not sure. Is that the truth, or do we need to see a trend? Do I need to see two or three years of the fixing? So we want to make sure that we’re getting out in front of it two or three years to identify, what are the things that you would do?
It could be bringing in our bookkeeper or CPA to fix our chart of accounts and to handle our accounting to make sure we understand, are all of our clients profitable? Are all of our service offerings profitable? Maybe we need to look at what we charge per se and look at if there are accounts that we might need to purge.
Maybe we need to go back and come up with a new contract that is assignable or get off of legacy agreements that were there 10 years ago. We can’t just do it all at once, we need to spend two years going through the cycle of getting back in front of customers because they might be softened into it, and you’re wanting to sign a new agreement in year two. It takes time for everything to flow through, so you need at least two or three years to start making these changes.
Without making large structural changes and big investments, very often this blocking and tackling could mean 10, 20, 30% in a deal. So just really simple conversations to identify some of these red flags. Take a $2 million deal. That’s 10%, $200,000. So take any multiple of that you’d like, that’s pretty significant increases to the bottom line without making structural changes to the organization.
There are other reasons why it could be longer. Maybe a buyer has…Excuse me, maybe a seller has certain goals in terms of what kind of number they want to hit. And maybe now they do need to make structural changes in terms of how they invest in their business. Or maybe there are tax issues. So for example, if I’m a C corporation subject to a double layer of taxation and if a buyer is going to buy my assets instead of my stock, there are periods that it will take to convert the entity to be taxed as an S corporation or an LLC. And so I might need that five or 10-year time horizon to get better tax treatment.
There are many different things that could be addressed that need time to flow through to increase the value of the business. And so for an owner who’s looking to do a deal, hey, you don’t need any time. But you are a deal taker. If you want to be a deal maker and get better pricing or better deal structuring, it’s really that two or three-year-plus horizon that would behoove the owner to have the dialogue.
Russell Benaroya: I love it. Do you want to be a deal maker, or do you want to be a deal taker? So good. One last question for you, Randy. What is something that people don’t usually ask you that you wish they did in sharing about Synesis or this industry or your experience? Just what comes to mind for you?
Randy Katz: I think that many business owners have a misnomer. And it would be, “I already know who’s rolling up the industry or I know who my buyer is.” And so there’s an idea that a deal can be completed without an intermediary. It’s true, that deal absolutely can be completed without an intermediary. The question arises as to, will you end up with more money in your pocket after paying taxes and fees by using an intermediary? Or will you end up with more money after paying taxes and fees without using one?
There are many, many reasons why the value some type of intermediary can bring to a deal is over and above their fees such that even if we think we know who the buyers are, we should still bring in another party. I think the questions that the sellers may not ask when they think they already know who the buyer is or who the industry buyers are because they’re rolling up parties is, what kind of value can you bring to the table? There’s very significant value in having an intermediary.
Not all intermediaries are created equal. But any deal, for example, there’s not just one price. There’s going to be a range of prices that is likely, and that range is going to be a function of many things. One is the compulsion level of the buyer and the compulsion level of the seller. One is the amount of competition or sometimes even the illusion of competition that you have.
For example, the seller who knows they have a buyer, what I know from being in the business is that when you have one buyer, you don’t have them. They have you. And so there are many situations where you can go down a path with that buyer, and you’ve got your travel agent on speed dial. You’re mentally checked out. They get to the two-yard line and decide that they want to renegotiate the deal, and they’ve got you over a barrel.
There are certain processes that you can follow that will keep those types of things from occurring. There are also, well, two separate issues where my mind is going. One is there’s a market way of doing things. We think of market price, but there’s also a market way of things that might pop up in a purchase agreement that are legal issues. There’s also the market way of what types of things might be released at a certain time.
We can help identify for a seller, what is the market? What’s normal versus abnormal? Are you releasing too much information too early in a process that if this deal doesn’t close, you’re going to be harmed later? It could be managing the process and avoiding what I call data purge. So a buyer asks for information, a seller provides it. Well, gosh, if the seller doesn’t know what a buyer is looking for, how do they know if there’s anything negative that’s going to pop up?
Buyers are great at asking for certain types of data that might mask what they’re looking for, and then they can find either the big positive or the big negative. Well, if someone in my shoes knows what the buyer is looking for and we identify those red flags ahead of time, you can get out in front of those issues. Frame the narrative for the buyer before they come up with their negative narrative and explain, “Here’s the issue you’re going to see. Here’s how we would deal with it or why we don’t think it’s a problem.” Or, “Here’s the big positive, and here’s why.” And those types of things will increase the chance that your deal closes and closes at a higher price or a better deal structure.
Now, this is less valuable yet, of course, of immense value to an owner who is inundated with questions and data requests is being able to take some of that off the owner’s plate whether it’s through asking ahead of time before they go to market or getting it in a more systematic manner than getting 100 data reports all at once. It could be bringing in the team members who are going to help the owner do these things. Sometimes it’s expectation setting, just getting the owner’s head wrapped around what’s there.
It could be bringing in the right parties. An owner might go to their attorney because they’ve worked with them for the last 20 years, but it turns out that attorney doesn’t have experience in the M&A world or it’s their family friend who is a litigation attorney who attempts to manage a transaction but doesn’t know how to manage it. And bringing in the right parties will increase your chances of a deal closing.
Yes. I started with, what question would they ask? I think that it comes to, what are the different ways that an intermediary brings value? And are there ways that you can help even when I might think I know who my buyer might be or who the types of buyers might be or who the 30 buyers might be? And then I think we can identify ways that, “Hey. It makes sense to have conversations with us in virtually any scenario, and there’s probably a value on.”
Russell Benaroya: Awesome. Randy, thank you so much. I’m going to share with you six takeaways that I had here. I’m sure there were more, but this is what stood out for me. So one is, do you want to be a dealmaker or a deal taker? That’s on my mind. When you have one buyer you don’t have them, they have you. That’s on my mind. Love it. Know your time horizon. Know what type of buyer you’re looking for. Know what asset you’re selling. And the most recent point you made is to get in control of framing the narrative, which I think is a really useful takeaway.
I know there were many more. There were just six that stuck with me. Super rich conversation. Not only about the tactical process of approaching and ultimately transacting the sale of a business but also the emotional process of going through all of the considerations that come with affecting what may be the biggest transaction that these individuals will ever be a part of.
So thank you for bringing your knowledge today specifically talking about MSPs because, again, like many industries, this is a highly fragmented industry with a lot of players and a lot of opportunities to create real value to the extent that the business owner is thinking about what they can be doing to increase the probability that they can realize equity value.
Randy Katz: No, I appreciate you having me. Awesome.
Russell Benaroya: Oh my gosh. Such a pleasure. Everybody, thank you so much for listening to this edition of the Stride 2 Freedom podcast. We will be on again in the next couple of weeks. Have a great day. Talk to you soon. Bye.