Building Wealth vs. Income for Your MSP with Scott Hamlin, Financial Coach at Pax8 Academy

Russell Benaroya: Hey, everybody. Welcome back to another episode of the Stride 2 Freedom podcast where we help business owners get and stay in their genius zone. You know me, I’m here every week, Russell Benaroya, your host of the Stride 2 Freedom podcast.

The Stride 2 Freedom podcast is sponsored by Stride Services. We help business owners get and stay in their zone of genius through comprehensive back office, bookkeeping, accounting, and fractional CFO support. Today, I am thrilled to share that we are going to be talking about something that really piqued my interest a few weeks ago when I was speaking with Scott about the distinction of building a business that creates wealth versus a business that creates income.

Scott Hamlin is such a perfect guest for this because he has not only traversed the journey as an entrepreneur himself, but he is also in the business of guiding other entrepreneurs specifically in the IT services segment to do the same. He is a senior coach at Pax8 and joined Pax8 in a consulting capacity after Sea-Level, which is a very well-regarded operational and financial consulting firm to help guide MSPs to create equity value, not just a JOB.

Scott provides coaching in the areas of financial management, owner-level coaching, and operational processes. And he’s been doing this work for 30 years. Scott, how are you today?

Scott Hamlin: I’m doing awesome. Thanks for having me.

Russell Benaroya: So great to see you. For those of you that don’t know, Scott and I met back in 2005 when you were running PacketDrivers, which was a well-respected MSP at the time but you have since sold it. We were running a healthcare service company and acknowledged at the time the quality and discipline with which you provided services. The fact that we came together serendipitously a few weeks ago is really a gift. I’m excited we reconnected

Scott Hamlin: It is and I’m excited as well. It’s fun to see both of our journeys over the last almost 18 years if you go back to 2005.

Russell Benaroya: When we talk on the podcast about helping business owners get and stay in their genius zone, that thing that people do where they lose track of time, where if they could get and stay in that flow a larger percentage of the time, their quality of output would be higher, their life satisfaction would be greater, what do you think is your genius zone?

Scott Hamlin: I guess a couple of things. My biggest passions are about coaching and growing people. That’s what my business was about. There’s a lot of things I didn’t do well in my business like all of us. One of the things I did well was find good people, particularly inexperienced ones and grow them. So I have this passion around that.

I also have a really big passion around acting like an adult when we run a business or acting like an adult when we think about our home finances and talking about income versus wealth. My passion is around the idea that let’s act like an adult, let’s act like a mature person, and manage our responsibilities and our business when it comes to finances. Those two things come together when I get to do this work.

Russell Benaroya: I would love to dive into what it looks like to not act like a mature adult in your business. What do you see? What are those attributes or characteristics so some of us can self-identify our behaviors?

Scott Hamlin: Well, I’ll stick to the finance side of it. We can see that across all sorts of things. If you think about The E-Myth, particularly in the MSP space, you’ve got a lot of people. I often say you own a hobby, a job, a business, or an asset. A lot of people started the journey almost as a hobby, maybe as a job. When people aren’t acting like an adult, it’s about not taking that responsibility that this is a business.

You have a responsibility to your family if you have one. You have a responsibility to your employees. From the financial side, it’s about taking the time and effort to focus on finances and understand what you’re doing with your business. So you’re starting to reduce risk. We see people behave in a way that they just ignore it and put their heads in the sand.

I have calls like that where we’re looking at expenses. You need to reduce them because we’re not doing the things where we need to do to have a healthy balance sheet, healthy income statement, etc.

Russell Benaroya: Why do you think many business owners put their heads in the sand? Is it fear? Is it a lack of knowledge? What is it?

Scott Hamlin: I think it’s a lack of interest oftentimes. I hear that a lot from business owners, “I don’t understand financials, I don’t want to understand it.” There are things in our business that we do that, that maybe we outsource almost all of it. But you can’t outsource your responsibility for understanding the financials of your business.

So I think lack of interest is number one. Then number two is not a full understanding (of money). Money is not about getting a Porsche. Money is about security and choices in our future. So it starts there. I don’t understand why there are as many business owners that don’t look at their business that way and think to themselves, “I’ve got to build security and reduce risk and build for a future.”

Russell Benaroya: Is that the distinction to be made between building wealth and building income? I really want to headline that concept because I think it dramatically changes the profile of the value that is ultimately getting created.

Scott Hamlin: I start with the right income and wealth at a personal level. We see lots of people that are driving around in really nice cars and maybe a nice house, which, a house appreciates, a car depreciates. So if it’s a lot of cars, you’re definitely not building wealth. What we see is you might have a lot of income, but did you build any actual wealth around that?

When we translate that to business, wealth is something that can sustain itself. It can generate its own new capital. Having a business that generates enough income that you can live on as a business owner, and there are still a lot of businesses in that space and that size.

Wealth is about building an asset in your business, and/or taking equity out of that business and building an asset around that so that it has value that sustains beyond just that income.

It’s funny, you asked about this concept. I thought about it more on a personal level. But when we think about building wealth in a business, I have a $20 million business. Let’s be honest, it’s worth something regardless of what I have personally, or regardless of how much is in the bank for the business.

Running a $3 million business or a $4 million business, that might not be the case. It may not have enough value around that. So within a business, when we’re talking about building wealth, I was talking about choices. It’s the same thing in the business. When you have cash, you build up the equivalent, just within the business, I have choices.

I was talking to a client the other day. I said, “You need to hire two salespeople. You’ve got a million dollars of cash on this, let’s invest it.” So that’s wealth. This person has built wealth in the business and separately, not just income, and now he has choices. A person that lost two clients doesn’t have that cash in the business and lost their choices. They’re forced to make some different decisions.

Russell Benaroya: What are maybe three to five pieces of advice where you would guide owners on how to think about wealth creation that they could take back to their business today and take a critical eye to their decisions, their investments, and their outlook?

Scott Hamlin: The first thing I would say around business, and particularly in that $3-$6 million range, is when you’re thinking about wealth, this is your business. Start to think about pulling some of that out and building wealth outside the business.

The number one advice I give to people in that size range is to plan your future in your retirement, not selling the business. You’re asking about common mistakes. One of them is, “I want to sell my business. That’s my retirement.” So take that wealth outside of the business.

I also talk often about, if you’re a standard MSP business and you have a cash flow problem, you have a profit and loss problem. Maybe if you’re selling a bunch of hardware, but even then, we should be able to handle it. The important part of this is to manage that P&L to generate a profit. That’s why we’re in business. Why are we taking risks and doing all these things if we’re not generating profit? That profit built into the wealth in the business allows us to make choices, grow the business more, and pull that wealth outside.

Another part of that is why we see these challenges. Oftentimes, I think it’s a lack of interest. Commit to understanding financials and managing your business. If you’re not doing that monthly review, if you’re not using something like service leadership as a tool to categorize different buckets of gross income. If I’m in managed services, I have to be making a 52% gross margin. If I’m selling a laptop, I have to make a 20% gross margin. If I intertwine those two things, I don’t understand my business.

So, understand how that works, and then manage it not just on a yearly basis, or a quarterly basis, but a monthly basis. When you understand that, it allows you to make those decisions. So cash is king. It’s an old concept. The more you build income, the more you build cash, the more flexibility you have around building that wealth.

Russell Benaroya: What I’ve experienced is that building wealth is a step-function method of investment. What I mean by that is, to build a business to go from 1 million to 3 million, 3 million to 10 million is not just about doing more of the same. It is about investing in systems, people, and processes at another level.100% of the time, the investment required precedes the growth into that size of business.

What I’ve seen many times is that you are the least profitable when you’re in that $3 to $5 million range because you’re in that ambiguous middle zone. I’m wondering how you guide owners to take that leap? Because it’s a leap, it’s a profile change in the business.

Scott Hamlin: First of all, on that concept, when I sold my business, there’s a lot of things I respected about Patrick. We’re going to make a profit and we’re going to run this business that way. But if we decide to go from 20% down to 10% EBITDA, as long as I understand my numbers, and I can understand that, I can think of it as investment as long as I manage to it.

Now, a lot of times we have a $3 to $5 million business, and they’re just make a leap. The advice around that is that financials are about making intentional decisions around what you’re doing. We talk about these different barriers, and you run into them all along. I have not managed a $100 million business, but I suspect they run into walls, too, like everybody else.

So when we get to the size that you mentioned, those processes, those financial statements, all the things around your business become so much more important, and they can get off the rails quickly. I often talk about revenue, and if we’re going to grow revenue, it’s not about growing revenue, it’s about growing good revenue. You can destroy your business very quickly at $3 to $5 million if you start taking on three clients outside of your target client profile. So get those processes in place, understand your numbers, and make intentional decisions around breaking through that next level.

Russell Benaroya: I imagine when Scott Hamlin descends on a client with a tremendous amount of knowledge and experience, that a client, while very motivated and energized, could also feel overwhelmed. Like, hey, where do I begin? How do you navigate through the journey, grab their hand and point down the river, and do it in a way that maintains their energy without having them feeling like, oh, my gosh, I am swimming?

Scott Hamlin: Well, I will say this, I’m pretty fortunate that most of the people that I work with, something’s brought them there. I talked about maybe a lack of interest in financials, but I’m not running down the street grabbing some MSP owner and saying, “I’m not interested.” We don’t have any problem around energy and getting going. Certainly, there can be some frustration in that journey in terms of getting there, but it is amazing.

I’ve already been on two calls this morning. I was talking to somebody; it was a relatively small business. She does the books in the business and she was talking about gross margins. I needed us to get the numbers and ours was 42%, but I don’t believe it. I was like, “Great, I’m glad you don’t,” because she wants to understand what that is.

I’m fortunate that I’m getting people that are at that point. You have to find it within yourself as a business owner to realize that that matters. Once you do that, you’re going to have enough passion once you start to see the numbers and what really generates profit.

We’re going to go through another transition in the next 5 to 10 years about the way we sell MSP services. Is it going to be one package that includes all of your services? We have to understand. How we model it and price it and all those things

I think a light goes off when people understand how they’re really making money versus just going out and selling it; I got this much revenue and this much cost and I don’t understand it.

Russell Benaroya: If I were an MSP owner and I was trying to self-assess whether or not now is the right time to call somebody like you, how would I know? What would I be feeling/thinking/seeing that would lead me to it?

Scott Hamlin: Certainly, the obvious one is when we have financial trouble and we don’t understand why we have financial trouble. That said, that’s a relatively small percentage of the people I work with. I would say most people, when they realize that they want some help is when they look at the financials, they see the results. Now, this doesn’t always mean bad. It might be good.

I work with partners that might have 22% EBITDA, which is a very good performance in this space and they have no idea why. It’s when you realize that you want to do something with your business and you don’t understand what’s really going on from a financial perspective in the business. That’s it. It’s that simple. We help align it, and then we help dig into why.

First, leadership is a great tool. I often talk about, “This is a book with numbers. I’ve got a 27% gross margin if I can even trust that number.” Why? That’s when the light bulb goes off for people.

Then how does it scale? I have quite a few calls where our profitability is good, but managed services’ gross margin is poor. Maybe they’ve added some ancillary services, and they’re able to mark it up 100%, which isn’t something you could really do on the open market, and probably isn’t the way it’s going to scale. You’ve got to fix it. You can’t scale the business. When people understand that, that’s when the lightbulb goes off.

Russell Benaroya: Talk a little bit about inter-month versus intra-month financial management. What we often see is, as a business owner, I don’t pay attention, and then I get my financials on the 20th of the month, and then I freak out. Then I get settled down and the journey continues. Versus, I’m able to keep a pulse intra-month. I recognize it’s hard to do real-time accounting, but are there things that I can be looking at during the month to give me a pulse on how we’re tracking?

Scott Hamlin: You’re being quite ambitious to talk about intra-month. Think about that question. I think it goes back first to financial alignment and understanding the numbers. I might be a business that covers all my recurring costs with just the managed services. It’s still important to know what all those other numbers are. Versus a business that not only does not cover it, but it’s counting on $50,000 a month in non-recurring services revenue to get to 5% EBITDA or something like that.

Once I understand what those numbers are, now, I understand what’s important, intra-month. I have partners that I work with that are in that boat where they need that non-recurring revenue to get there. So it’s all about finding the right KPIs intra-month to understand not just intra-month. It’s intra-month in February about what our project pipeline looks like. How many VCIO or quarterly business reviews do we have scheduled? So that I’m projecting out and can hit those numbers.

And then having KPIs during the month. It might be non-recurring product sales. It probably shouldn’t be if you’re an MSP, but certainly, that variable number. We talk about accounting catching up, it’s also understanding what those costs of goods sold and expenses are and how something might be impacting this particular month. So, understand the numbers first to really understand what’s important, and then it’s KPIs to monitor that during the month.

Russell Benaroya: Can you talk a little bit about reports that you guide MSP owners to be looking at? Again, the numbers may not be correct, but what are the core sources of reporting that you guide them to as the foundation for having a discussion and making observations?

Scott Hamlin: One of the things I do when I’m coaching with somebody, if they’re using QuickBooks, I’m setting up reports so that I can see them in real-time. I remember going into a peer group and somebody was talking about the balance sheet. “The balance sheet is the most important thing.” It’s reiterating what you hear about Fortune 500 companies.

For the average MSP, the only thing on the balance sheet that probably ought to matter is your cash and receivables. You shouldn’t have debt. But cash is important. That’s the first thing that flexibility and choice and lowering risk are about.

Then it’s about understanding our gross margins or gross profit. So, in your financial reporting system, having reports that are going to show you what you’re doing in gross margin. I look at a full P&L, I look at the bottom line. And if the bottom line says 5%, I want to go find out why and build a story. If it’s 20%, I want to build a story.

The other part I talked about, even if you’re doing well, is understanding why we’re doing well. Maybe we’re doing well in the last six months because we did have a whole bunch of non-recurring product sales. I’ve got my head in the sand and I don’t realize that that was because COVID came along, and people were investing in remote work. You have to understand that.

So, building those gross margin reports and having those accurate numbers, I think are the fundamental start of a business. Then when they don’t make sense, now we’re looking at the MSP CFO to better understand where the root problems might lie that are causing those numbers to be something other than what we want.

Russell Benaroya: How do you guide owners on this concept of leveling? Leveling in that, at some level, there’s bookkeeping and accounting work that needs to be done. That’s generally a rearview mirror-looking set of activities. There’s a forward-looking set of activities, which we call Financial Planning and Analysis, or at the highest level would be fractional CFO. But it’s not enough to just say, categorically, “You need better accounting and financial management,” and believe that that resides in a single individual or a single function.

How do you guide an MSP owner on that leveling structure and where to make investments and at what time?

Scott Hamlin: We talked about tracking what we expect. And on the financial side, particular things are out of alignment pretty quick. Every business is different. We might have an owner that is financially literate, and maybe a partner in the business that also can manage a bookkeeper, even if it changes every six months. And they can sustain that right and do their planning and look to the future.

In other cases, we don’t have that and we need to outsource. Getting the right process, and numbers and then consistency is super important. And when you need a CFO, we can throw terms like CFO, financial analysis, we could use all sorts of different terms. But as we grow, we need to understand better our inputs, our cogs, and our revenue and be able to analyze that.

And the more you want to grow, the more important it is. I always tell this little joke. If it costs you $1 to build a widget and you sell it for $0.99, how many do you have to sell before you make a profit? All that’s important, and it’s even more important if you truly want to grow your business. You’ve got to get it right.

That’s the time when you start to think. Maybe you have an owner and bookkeeper that can inspect that process, and they can plan. Maybe you’re not that person, and you need to look to other resources for that.

Russell Benaroya: Yeah, that’s, that’s a really nice break point. There’s this natural point of evaluation to say, “Do I have the right team around me on the finance side to support me in getting there?”

Scott Hamlin: I run into partners that outsource their finances, and I often talk about accountants. But they’re not always about financial analysis. We have accountants, but it’s also understanding the industry. I know we’ve had challenges around that. We need to do this that’s more industry-specific and not just getting bookkeeping done so I can give everything to the accountant to file taxes. It’s not what we’re about.

Filing taxes is just a necessary evil. And hopefully, you have to pay a lot of them. I’m not advocating for high taxes, by the way, I’m just advocating for high profit. Hopefully, it’s a 1% tax rate, but billions of dollars of profit.

Russell Benaroya: The last part of this discussion that I think is really important in the discussion of income versus wealth is the realization opportunity of that equity value you’ve created or the wealth that you are ready to realize from this business you’ve put a lot of heart and soul into building.

I’m curious if you could talk a bit about how acquirers are going to be looking at or evaluating this asset that you’ve built for you as the seller to get the most wealth creation from that asset.

Scott Hamlin: We talked about multiples of EBITDAs and overinflating their numbers or under inflating them. And talk about the concept of the buyers multiple and the sellers multiple, they’re not the same thing.

I did a webinar with the company that acquired mine a year or two ago and we talked about that.  I think particularly as we get more private equity money they’re looking at a business and wanting to understand what those numbers mean. So even if you’re not making as much profit, if they can decipher when and why, they might be willing to…

By the way, that difference is multiple, they’re not going to give it to you as the seller. So, if you’re running a poor business, too many dispatchers or project managers, we’ll pay you what the multiple would be if you didn’t have them. They might give you a little more, but they’re not going to pay you for it.

They’re looking for a profitable business. And the more profitable business you have, the more they’re forced to pay for that. If I’m a buyer, and if I can see that, if it’s clear to me where you have the problem, I’m going to underpay you. So, as a seller or somebody that’s trying to realize that wealth we talked about, and by the way, I wouldn’t be doing my job, which is to say, counting on that.

If you have a $3 million business, if that’s what you’re counting on, you’ve got to pull money out of the business and invest in the market. So you have that and you can combine it. Having those good numbers forces that buyer to pay for that gross margin ultimately, or EBITDA is the way we calculate it. But ultimately, a lot of it has to do with gross margin because a lot of that overhead is going to go away.

Russell Benaroya: Yeah, and it increases a lot of confidence in a buyer when you can demonstrate that you have command over your numbers. It doesn’t always have to be straight up into the right, but knowing what happened, why it happened, and giving them trust that in their due diligence, they’re not going to find any surprises. It’s the undermining of trust that gets people skittish about paying for multiple.

Scott Hamlin: You’re talking about understanding numbers. Somebody with a buyer had an acquisition target, had a letter of intent. They started to go through diligence, and the seller had to back out because they didn’t understand that they had to pay back all that deferred revenue. You’ve got $150,000 of deferred revenue, that’s still an obligation of the buyer to do that.

Go a step further. There are a lot of people that don’t have it as deferred revenue. But if the buyer is doing their right due diligence, and they find out that you’ve collected $150,000 of revenue, it’s on your books as past revenue, but you still have a debt obligation, you’ve got to pay back that buyer because they have to go service that. All that stuff is pretty important.

The only way you get there is to understand the numbers even if you don’t really enjoy it. You don’t have to be a financial expert, but you have to understand enough to be able to operate the business.

Russell Benaroya: Know the right questions to ask and equip yourself with the right people around the table, which is a good segue into my last question. How do people engage with you, Scott? How do they find you? How do you enter into and manage relationships?

Scott Hamlin: True disclosure, I’m semi-retired and work part-time. Most of what I do at Pax8 within the Pax8 Academy is all around financial coaching. But as an organization, we provide coaching to MSP businesses, and it starts on the operational level. We have content that goes all the way, including through the financial part of it.

So, if you don’t already engage with Pax8 through the services, you can certainly go to the website and learn a little more about the academy. There are links on the website that talk about it. It’s all about empowering MSPs to be better business owners. I do it on the financial side, but it’s all about the right process and being a good operator.

Russell Benaroya: For people to find you, would they get to you through Pax8? Or would they just reach out to you?

Scott Hamlin: They go to Pax8, for sure. I work part-time. My email address is shamlin.c@pax8.com. We’re all about getting people in the academy, educating them on a whole bunch of different levels, and then the financial part of it comes to me. If there’s a need, you can certainly reach out to me directly about that. We want to empower the community. That’s what we do.

Russell Benaroya: Scott, what I appreciate so much about this conversation today is that you’ve come full circle to being in a space where you’re giving back to a community that has given you so much, that you’ve learned so much from, and you’re trying to pass on some of this learning and discipline to help other MSPs create a future of wealth however they choose to define it. That’s really admirable and I appreciate you coming on the show.

Scott Hamlin: I appreciate it. It’s fun and I appreciate you having me on.

Russell Benaroya: All right. Thank you so much, everybody. Have a great day and we will see you on the next episode of the Stride 2 Freedom podcast. Bye.