What's a "quality" MSP, and does your business fit that description? When it comes to mergers and acquisitions in the managed service provider channel, quality has a specific meaning.
In this episode of our video series about M&A in the MSP channel, Cogent Growth Partners leaders Bruce Teichman and Rick Murphy join ChannelE2E editorial director Jessica C. Davis to talk about "quality" MSPs.
The discussion focuses on what makes an MSP a desirable target for another MSP or a private equity firm as a potential acquisition. Teichman and Murphy share their insights on this question based on their years of experience on the ground putting buyers together with sellers and getting deals done.
This is a regular series. If you have a question you'd like this panel to tackle in a future episode, please send it to [email protected] with the subject line: Cogent Video.
Transcript: What makes a "quality" MSP?
Jessica Davis: Hey everybody, Jessica Davis here, Editorial Director of ChannelE2E. And I'm here today with a couple of the partners from Cogent Growth Partners, an M&A advisory firm to the IT services space. And these guys are experts on mergers and acquisitions for MSPs and technology service providers, all kinds of service providers in the IT services space. So we're really lucky to be able to talk to them on a monthly basis. It's very exciting.
This is our second edition. I'm here with Rick Murphy and Bruce Teichman. And we talked about this last time, about what the question of today would be. And it's going to be all about quality. What is a quality MSP? But before we get to that, I wanted to talk about trends that we're seeing in the market first about MSPs and how they're doing. I know that there was a new Service Leadership report that came out recently showing that revenues were a little bit down, even though profitability was a little bit up. And Peter Kujawa of Service Leadership was noting that maybe it's because it's an election year this year and there's a lot of uncertainty. He's seen some correlations And I know, Rick, you were talking about what's going on with small businesses today and how that's impacting MSPs.
Rick Murphy: I actually pinged Peter, when I saw that. He put some stuff up on LinkedIn, and I had seen that before. And you've got to really give that a macroeconomics picture. It's not just about interest rates. It's small businesses across the country, I'm not going to go with worldwide, but certainly in the United States, have taken a hit in the past two or three years.
Certainly in the past year or so, as inflation and interest rates and what have you happen. There's government policies -- pick the state of your choice -- with things they're doing with labor and hourly wages. It's put a big pinch on small and medium-sized businesses, which are the core clients of the bulk of what Peter's constituency is. Most of the managed services companies are serving small and medium-sized businesses.
And if the small and medium-sized business isn't doing very well, they're not going to buy more stuff. They're not going to enhance their network. They're not going to have any money to do different things they want to do. They're just going to kind of subsist. So I think that's why the revenue hasn't really gone down, so to speak. This hasn't been a downturn, but it hasn't been an upturn. And it's just been kind of trundling along. And that's my opinion. Bruce, what do you think about that?
Bruce Teichman: I agree with that. So there's been a lot of focus internally because of rising costs, and the cost of labor. A lot of MSPs have been examining their tool set and how can they be more efficient, save a little money. So maybe on the same revenue, they're making a little more profit. AI is starting to come in and speed things up. It is in its infancy, obviously. But I sat in a session on that recently, on how AI inside the MSPs operations are starting to save some money, really.
Jessica Davis: That's interesting. And so you believe that it will have an impact going forward on profitability and efficiency?
Bruce Teichman: I think all these technologies that help you make it do it faster, smarter, cheaper.
Rick Murphy: I think you have that backwards, right? Efficiency and then profitability. The more efficient you are, the more work product you can generate. I know a lot of people hate that term, but it's definitely true. The more work product you can generate with less people, then you're more cost efficient, so your margins are better. Hopefully, everybody on their team prospers and it passes through to the employees and so forth, and certainly keeps customer costs in line and things like that. I think some of it's out of necessity, Bruce, also. I think some of that you have to do to be able to maintain profitability. Because again, if your customer base is flat and or maybe descending in terms of what they can do, the end customer of the individual TSP, well, then you're going to have to make sure if you want to maintain profit, you can't just keep spending money on things that are more gambles than sure things.
Jessica Davis: Great insights. And it brings me to the topic of today. Investors in MSPs are looking for quality MSPs to invest in, to acquire, and there may be fewer of them than they would like to be in the market today. Which begs the question, which we talked about last time: what is a quality MSP? And I know that there are probably a number of factors that add up to what a quality MSP is. I'm wondering if each of you might give me your top three factors for what makes a quality MSP.
Bruce Teichman: Yeah, we mentioned it last time that it's hard to find quality mature MSPs. There's just less of them, right? And part of that is this concept of the lifestyle business. A lot of the smaller MSPs are running their business as a lifestyle business. It's not about the business. It's not about profitability and culture and leadership and understanding all their metrics. They're like, hey, I make some good money. I am having fun I help people. It's kind of general, and a lot of the smaller firm -- certainly ones that are five employees or less -- or even up to ten, have that lifestyle mentality.
Then you take those even at that size who've decided hey this is this is a real business and I need to learn how to maximize that and be efficient and raise the quality and so forth are joining peer groups they are talking to advisors and just the idea that they want to do it is is a great step. That definitely makes a quality MSP. These folks that are out there so educating themselves and having made the decision that they are going to improve their business. I know it's kind of high level but I think that's a big one. It's just this decision to invest in management and leadership and culture. That's not really hard KPI type stuff.
But that's where it starts, because if you have that infrastructure in place, then you're taking care of your employees, which are, again, lifeblood of the business, and giving them direction and setting up the proper kind of incentives. And all these can be sort of complicated, whether it's sales employees or engineering resources or what have you. So investing in your people and investing in, you know, like I said, sort of maybe some middle management. You got to get to a certain size to get there. But just one assistant, you know, it's very hard to this single owner run business who's still doing the technology, you know, doing the selling, doing the everything to have that, you know, sort of maturity.
Rick Murphy: Can't do everything by yourself.
Bruce Teichman: Can't do everything by yourself, right? Yeah. It's lonely at the top. So that's, I think that's one thing. I think, you know, another big one, we talked a lot about it last time, but it's still true, is just this whole financial structure that these companies use.
What makes a quality MSP is someone who has spent a little bit of time understanding that from their own financials, from their own P&L, they need to be able to recognize so they can operate it better. Things like, how much do I make on recurring revenue, and what is recurring versus one time, and product margins, and subscription margins, and all these things, doing it in that accrual fashion as well. Cash accounting paints a false picture of your profitability month over month, quarter over quarter. Very hard to make good decisions.
I think a quality MSP is someone who sat back and said, you know what? I'm going to get this right. I'm going to invest in a little time. Maybe they don't have a full-time CFO, but they have a fractional CFO, they're outsourcing it. So they have just a great bookkeeper-slash-accountant.
I'm working with a company right now, pretty small, you know, under a $2 million business, but they have like rock solid financials and it has helped them manage the business. We're in deal mode. There's an M&A opportunity, and it is worth more to the buyer because they're less uncertain about what they're looking at. There's a certainty and clarity that came with the right kind of bookkeeping, if that makes sense. They see that as quality, and it is.
Rick Murphy: I have a couple more. I think that when we talk with our clientele, we work with all sorts of private equity groups, private equity-sponsored operating companies, or operating companies that are on their way to wanting to be sponsored by a PE company, and some smaller companies that are just kind of really getting going in that $5 million, $6 million neighborhood they're trying to get bigger and see the future, usually run by some younger people that are a little newer at it.
I think the biggest thing that our buyer community looks at, and I think it's something that you can make money on by yourself without doing an acquisition is sales process. Sales processes is something you can learn. A lot of people are technicians that build and buy these companies. They don't have the skill set around sales a lot and they're trying to hire it and make that happen, and those companies don't really have good sales process.
We hear a lot of people say I get all my business from referral. I don't use contracts. That's a whole show by itself. But the short version of that is, well, the biggest asset you have is your customer relationships. And how solid are those customer relationships? It is contract dependent to some degree? So again, you look at an operational maturity level. Do they have good sales processes or not? Is all their business coming from what we call hunting versus from farming, where you've got referrals and you're farming current business.
And growing that and getting referrals, there's nothing wrong with that at all. But if you couple that with a robust hunting sales process, then you've got a really good viable business, and that's worth more to anybody that would be a suitor. So that's one thing. I think part and parcel of that you see a lot of businesses that they're not selling at decent rates. They're kind of giving it away. Or they're not really being aggressive with their price points. We'll make it up in volume trick, right?
You want to make more money as a company. You want to do better as a company. A lot of things we talk about, by the way, have nothing to do with buying or selling your company in day one. And they have everything to do about making money now because if you can prove that you're making money, well then it's easier to, at any point in time, to think about selling your company, right? Or somebody comes along and knocks on the door and says, hey, I'm interested and you like them, which is a big part of it too, and again, probably a subject for another day. Assuming you get along and the culture fits, well then, you know, golly gee whiz, you're kind of ready because you already know what you're doing and you've got a company that's more viable because you can prove how much money you make.
Getting rid of the underperforming customers, a lot of people are terrified of that. They have what I like to call a top line disease. There's a whole bunch of other associated maladies that go along with that. Again, for another day, we could talk about that creates a staff infection, and often a staff infection has to be cured with a credit line addiction, so we can talk about that another day. It's kind of finance and a kind of transaction therapy all at once.
A lot of people we see, they have customers of $5,000 a month or more, and they've got a number of customers above that size but they might only have 20 of those customers in that neighborhood and all their other customers are below $1,000 a month. Or they have a bunch of customers like hundreds or dozens, and dozens and dozens that are below month $500. Is it actually more efficient to send the invoice out or not are you really making money on those customers?
You got engineers used to working on sub-thousand dollar a month type customers with that type of skill set, that type of frequency, and they're suddenly thrust into having to work on customers that are doing 5, 6, 8, 10, 12, whatever grand a month in business. Do those teams actually mesh well? And can the larger company service the smaller customers? So the engineers in the bigger company, they're not used to working for guys that are $500 a month. So it's an oil and water problem.
The sales process is one thing, but who are you selling to? At what price points are you selling it to them? And are you getting enough business out of that customer for that customer to be a viable customer as part of the customer list, which is the main thing that a buyer is buying is the customers and the employees. You've got to get the one that's 50-50. It's probably about half and half. Buying the customers and buying the people. Customers are probably 60-40 more important than the people, but they're right up there with each other. So let's get the customer part right.
Jessica Davis: That's like a ton of low-hanging fruit for MSPs to go after right there, right? Yes. Evaluating your customers and seeing if they're really a good customer for you, looking at your pricing, focusing on customers, focusing on sales, and also focusing on your financials and how you're reporting them, how your accounting is working, the type of accounting that you're using to showcase the quality of your business.
Rick Murphy: Let's bring that full circle for a second. Let's bring that full circle real quick. So the interesting thing is if you're focused on sales process, how do you know you're not selling enough to a customer? How do you know your prices are too low? Well, you have to have the financial acumen to get into your numbers. And see, if I have 50 people working for my company and we're doing $100,000 month, well, you can't run a business. My business will be bankrupt. Just to be plainly obvious. So there's variations on that theme. If you're doing $5 million in revenue with five people, wow, those people are highly taxed and they're not sleeping. And they're ready to put themselves out of their misery. So the happy medium is having enough people to satisfy the types of customers you're doing, and that's a fine line. So if you don't have your financials right, you don't know, right? So we can talk more about financials, but it's a yin-yang thing.
Bruce Teichman: I think it's all those metrics, right?
Rick Murphy: It's not spokes on a wheel, it's a yin-yang.
Jessica Davis: The financials are really your compass to figure out all those factors that you need to figure out
Rick Murphy: And then you experiment with price point. Maybe you can't get that kind of price. Maybe you have too many people to support the kind of customers that you're used to providing. Do I have the right talent to make those customers happy? Well, maybe I need to upgrade talent so I can upgrade my customers. Maybe I've got an upgraded customer. Whoops, I better hire some upgraded talent to go with that. So that's the flow of the whole thing. Having your finger on the pulse of just about everything we talked about today, which again, we could go on go on for hours about what we only have a few minutes. Yeah, I just think that's really fundamental. So having a good quality MSP.
Jessica Davis: Very good. That's a perfect way to wind up that topic. And gentlemen, do you have any closing thoughts today before we wrap this up?
Rick Murphy: Bruce, you go ahead. Well, I was thinking back to this whole topic and putting a bow on it. It is a little, ultimately, growth and retention. Are the two things right really am I am I growing consistently year over year you can't do any of that without these measurements and metrics and understanding where you are right. And the retention of your customers the retention of your employees speaks to the quality. You're assuming service they can do what they say they're gonna do right they're going to solve a problem and they can solve it right. But the retention of customers is a defining element of hey is this a quality MSP. They're getting a new one every once in a while, but they're going out the back door, they're not keeping them, therefore they're staying flat. So they still may, again, back to the lifestyle, they're in business, but it's not quite quality.
Rick Murphy: Let's bring that back into mergers and acquisitions. So if you think about everything you just said, a lot of the buyers are looking at the quality of the customer, but also do you have customer retention? A lot of our clientele how that is a specific KPI item in their due diligence to specifically voir dire and figure out what kind of customer retention do you have? What kind of tracker do you have on customer retention? That's one of the top things that Evergreen looks at. I know Evergreen is a popular company. A lot of everybody knows who that is. One of their top things they look at is your customer retention. Churn rate, things like that. Churn rate, yeah, things like that. It brings it back to what you need to be a desirable candidate company, even also to be a good buyer. All of these metrics are really important if you're going to be a buyer. I think that what we're talking about is how it relates to how you run your company every day, but making money now is something you can demonstrate to somebody else so that it looks sustainable that you're going to continue making money after we buy the company or after you join their team, things like that.
Jessica Davis: Very good. Very good. A lot to think about for everyone. But also, thank you for phrasing it in a way to where it gives people a way to focus on what they need to focus on. And so thanks to you both. Thank you, Rick. Thank you, Bruce, for joining me today and looking forward to next month. And if you have suggestions for topics for us, please send them my way. I will put my email in the show notes.
