EP272 - Why Owner Dependency Kills MSP Valuations with Stuart Warwick and Ian Luckett

IAN: In this episode of The IT Experts Podcast, we help you understand why owner dependency will kill your MSP's valuation.

INTRO: Welcome to the IT Experts Podcast, the only podcast to help MSPs scale to 1 million, and if already there, get to five and go faster. At the end of the day, isn't it all about building a business that works for you rather than you for it? I hope you enjoy the show.

IAN: Good morning, good afternoon, good evening. Welcome to The IT Experts Podcast. Today we've got Stuart back in the podcast lounge. Good morning, Stuart.

STUART: Yo, Ian, good to be back.

IAN: Yo, Ian.

STUART: Yo, Ian.

IAN: From the Lutton Posse. Here we are back in the hood. Great show got lined up today. MSP valuations, owner, not needed, owner's been stuck in the MSP. A lot of stuff we've been talking about recently in the Growth Hub. We've done some podcasts on this previously, but what we're going to talk about today is how, when you are an MSP owner and you are holding on to the reigns so tight and the business won't operate without you, ONN owner not needed, Stuart not needed. It'll kill valuation. Absolutely kill valuation. There's lots of other elements I'm sure we're going to cover off today, but this big one here is that unless you start to being your business is able to run without you and I'm going to caveat that, run and grow without you. It's all right going on holiday, coming back, and everything's in place, that's okay. But when your business grows without you, that's when you've got something magic.

STUART: It is. What this was stimulated by a conversation I had just the other week where someone has run, been in the industry years and years and years, got a nice business and they can't sell it. And it's not because it's probably not valuable. It, he's had three or four buyers start the process over four years. Because it takes time and it's fallen over.

IAN: Really?

STUART: It's fallen over and he's absolutely pulling his hair out because the clock is literally ticking. The biological clock is ticking.

IAN: Yeah. Yeah.

STUART: And it was like, it was really sad to hear because. It was like Groundhog Day. You know, we'd done podcasts on Groundhog Day and it's like, well, what do you need to change if you're going to get a different result, ie. to sell this business? And to the point where getting a bit desperate. So, that's what stimulated this conversation today, because there is a fear that you can't sell the business. It's not worth it. It's not worth what you need it to be when you need to retire. And as a result, you're going to be stuck in it or you've just got to wind it down and put up with what the reality is. And it doesn't have to be that way. You know, how do you build that transferable value that turns into cash in your pocket when you exit, that is worth having. But to, first of all, you've got to get it to a point where it. Where the multiplier, which is what everyone seems to be chasing or is chasing can kick in, rather than just getting one times your turnover or worse how do I build that transferrable value, because have I left it too late to build that value, exit planning will damage the staff morale because you know, you have to cut costs and shut, you know, shutter the business down to try and maximise profitability, sell it. Buyers will uncover the weakness. And just like this guy, there's, there are weaknesses and cracks in his business that the buyers are uncovering once they start their due diligence because due diligence is intense. That's the problem, but the opportunity, if you get it right, is you can exit on your terms. The business as a result of you getting it ready for sale is actually in a strong enough position to acquire. And so many businesses get themselves to ONN and really well structured and realise that actually this is great fun. I think I'm going to go faster by buying another business and strapping it onto what already works really, really well. Because you've got a model that works. If you go and buy a business and you are a bit of a chaotic business yourself, what do you end up with? More chaos.

IAN: More chaos.

STUART: If not going backwards.

IAN: Yeah.

STUART: So the key here , is you've got to put some key elements into the structure of the business to actually increase its value. And that's what we're going to talk about today.

IAN: Yeah. And you're going to cover off the element of the owner, the autonomous ability of the owner. But you know, analogy that I use and I talk to MSPs about is that, you know, we know that there's like 10 key factors of valuation multiplication as it would be. But the way to look at this is that. If you've got a million pound MSP and it's doing okay and you've got 250 grands worth of EBITDA that's your starting point, right? So if you're an average MSP, most will get one or two. So you'll walk out with half a million quid, you know? Alright, you've been doing it for 15, 20, 25 years, you're happy with that? I'm guessing kind of not. How do we get to some of these daydream multipliers that people talk about 8, 9, 10 times multipliers, you hear and you think, how the hell did you do that? Well, it's really simple because, and it is about not leaving it too late, you know, and getting in that process right now, because if you were to focus on your account management and you focused on your client concentration. There's a tick in the box that could be another multiplier. If you go and you what we talk about today, you know, you own and not need it, that's another multiplier. So we're now at half a million pound without actually doing anything and really spending much money. If you then went and focused on the contracts of your clients, which isn't going to cost you any money because you should be doing it as part of account management anyway. There's another quarter of a million pound, so before we know it you could easily be and by the way, there's another eight of these on top of that, you know, you could easily be at one, one and a half, if not 2 million pound cash in your pocket just by installing some simple, basic, good principles of running an MSP and today's one, you know, is the key one, which is when somebody buys your MSP, they will probably ask you to hang around for a year to make sure that the wheels don't fall off. But they don't want you in it. That's why they bought it. So, you know that's the kind of the nuts and bits we're going to cover off now, isn't it? But there's so much opportunity here that we are seeing and again, light bulb moments going on in the clients because they're going, God, if I actually do that thing that you've been telling me to do for the last two or three years, could that be worth, literally, you know. 250 grand and that's just a base on a million pound MSP. So multiply that up to a two, to three, to a 4 million pound MSP and you can do the maths.

STUART: Yeah, it is, and it is around the profitability of the business. Of course it is. And that is a function of your turnover to a point because, you know, world class EBITDAs or net profit could, to call it simple, you know, leading edges, you know, 20, 30%. So on a million pound MSP, you're doing very, very well to have an, you know, an operating net profit of 250,000. Many would dream of that.

IAN: Yeah.

STUART: After it's been adjusted, for example, you know, for example, we weren't going to all of that. So the starting point for most is focus on recurring revenue, you know, a number of our, you know, two, 3 million pound MSPs that come and join us are 50% projects.

IAN: Yes.

STUART: Which is amazing because they do amazing, they've got amazing client base and they just need stuff doing year in, year out. But it will impact the valuation. You turn that into a 75% recurring revenue business instead of a 50%. That's a massive.

IAN: Yeah.

STUART: So again, huge type of client you're targeting, the type of services you're offering and pushing. But those clients love doing the project work. And love, you know, being needed. So focusing on recurring revenue is key. Employing revenue per full-time employee is key. That shows an efficiency...

IAN: In the team.

STUART: Ratio there. That's really key. Contract length you touched on, that's really key. You know, many clients feel that, you know, they're doing their clients a service by saying, you know, it's monthly recurring contract. You can opt out at any time. Yeah, that's great if you don't feel it's...

IAN: Easy to sell, isn't it? To start with?

STUART: That's the point. It's easy to sell and it's a bit scary to say, well, it's a three year contract.

IAN: Yeah.

STUART: Okay. It's not that binary one month notice period, three year contract. But as you become more confident in your business and you realise that actually it's in their interest and your interest to, to build, you know, longer term contracts into it. Certainly starting with new clients who know nothing, legacy clients is a, it's a little bit harder to transition them because they're used to the relationship you've had with them for so many years. So why should they change? But it's not impossible. So contract length is really key. Looking at your margins around how you're buying things and so good business practice.

IAN: Knowing your numbers.

STUART: Knowing your numbers.

IAN: Risk mitigation.

STUART: Absolutely key on that. And service gross margin. Understanding the value of not only the recurring revenue that's coming into business, but the recurring margin that's built into that. And what sits behind that is the service gross margin which is looking at the profitability of the service desk and how that functions, because that's the next piece of efficiency below that, overall gross margin because that, that shows the ROI on the labor that is, is the core cost to the business? You know, most, most MSPs, their core cost is the technicians. So a 10 person MSP is probably seven technicians. If you're looking at the service gross margin that's coming from the help desk on those technicians that are involved in that, that gives you a real, that gives the buyer a real insight into the return that they can get from that business based on what they would pay from it. All of those things we've talked about to your point, can add a one, another one to the multiple. You know, from one to two, to three, to four to five, to five to six particularly. Then if you are, then the business is growing and you're getting past the million pound mark. We're at 1.11, 1.52 million on a 20%, you know, net profit or EBITDA number. You're starting to look at four, 500K and once your EBITDA or your net profit is above that 500K mark, you get another point of multiple that can kick in because there's financial reasons as to why that's more attractive to the buyer. But more importantly, all of these, metrics point to how good the business is functioning behind the scenes. So...

IAN: Exactly, exactly.

STUART: The reason that guy has got these people walking away is because, a) it was opaque, it was unclear what where the profit lay behind the numbers because the numbers worked for him, but they, it was unclear for the buyer as to where the profit lay or didn't lay. So therefore there was risk to them buying that business. And that's the thing, you're having to mitigate the risk that the numbers that you are currently doing are sustainable without you.

IAN: And the crazy thing about this is just good business practice in actual fact and you know, many MSPs are, they've got their heads stuck in, you know, sales and marketing. You know, they're not focusing on their headline numbers, they're not looking at the levers that you need to pull, and we've just embedded this. You might not know this, Stuart, but I've just built a thing in the back of our power app so that our clients can literally rag their valuation progress in their headline numbers, which is super cool. I'll show you later. But by doing standard business practice and starting with your sales and marketing, nice and slow and build that up organically. The journey that Stuart's just finished off with you had been a, you know, half a million pound EBITDA, go, going to put some petrol on it, now go and buy another MSP because you are stable, you are mature, you're structured, you've got a good culture, you've got good people buying another MSP yourself and embedding that in will then get you, you know, could double the size of your MSP and then they fall into the practices that you've got. All of a sudden you've got a 4 or 5, 6 million pound MSP that's worth. Even more. And you know, and then the numbers really do start to get very, very exciting. But it's all, you know, we are not saying that you've got to go and buy this magic pill. I'm not saying you've got to go and install all this IA. This is just standard. Understanding your numbers, understanding your people good. You know, industry best practice, you know, that we talk about in this podcast, our clients talk about everyone else we kind of connect with talks about and that. So how, how do we bring this one alive? What's the kind of the focus we talked about the recurring revenue.

STUART: I think it's really simple. If you are well established as a business, you're doing okay, but you know that the, if you were to sell it, you are way off the mark in terms of getting what you'd like from it. Depending on how, the extent that you follow the process and, hopefully everyone understands what we mean by that, because we talk about follow the process all the time with our clients is it's a three year process to, to turn the business around. Which is not a lot of time because this chat I was just talking about, spent four years, you know, with failed, buyers.

IAN: That's disheartening, right? Someone comes up to you and you sort of think your business is worth a million quid, and they give you, offer you a hundred grand or don't even offer you at all.

STUART: They walk away. They're walking away.

IAN: Yeah. They don't even give you an offer. It's like, what do I do now?

STUART: If you follow the process, it's probably a three year timescale to turn for many, it's probably four to five years, depending on how they need to extract themselves and how confident and brave they are in letting go, investing other stuff, because there's a whole load of other stuff that goes on behind this from your changing your leadership style to your confidence in letting go and hiring better people that can step up and work around you, putting the processes in place. But certainly, if you're really super, super focused and you are probably over a million already. It's a three year process. If you are really on the money and stay focused and accountable to doing the work for others, it's probably a three to five year process.

IAN: Yeah.

STUART: But we've seen the evidence.

IAN: Yeah, yeah, yeah.

STUART: We've got 50, 60 MSPs that are transforming at the pace that they want to pay, go their numbers and their lifestyles as a result of it and their opportunity to exit, because not everybody wants to exit or thinks they want to exit, but they actually do. Because there will be a point where you go, I need to get out.

IAN: And you will sell your MSP at some point, whether you like it or not.

STUART: Yes.

IAN: Even if you're at the bottom of the barrel, which we hope nobody on this podcast will be. And you're just selling your order book, that's the worst case scenario. But, you know, planning to exit or planning for that exit, you know, right now is...

STUART: Or structuring yourself.

IAN: Yes. Yeah.

STUART: You know, for that opportunity when it comes.

IAN: Yeah.

STUART: Because the benefits of all that in the meantime are ONN to what extent? Less time in the business. More profits. More fun in what you do. And that's what this is all about, is it not?

IAN: And again, you know, how's it going to work? There's lots of things we've just fire hose you with on how do we do it. Again, it's, it's just standard, KPIs, method of measurements, departmental plans, what does account management look like in terms of growth per client, profit per client, new business per client, employee engagement, all of this kind of stuff. We talk about it every single week, you know, and when you stitch it all together and then have regular rhythm of the review, which is, we talk about that, that following that process. It's that complex, isn't it? Which isn't complex or not, you know, it is not, it's not complex. It's straight, you know. It is a straightforward.

STUART: But it's difficult to do if you've never done it before.

IAN: Yes. Yeah.

STUART: And you don't know where to start. Yeah. And that's where it's like...

IAN: Yeah.

STUART: We'll start learning.

IAN: And just in case you know, any of you, shameless plug on our website, mspgrowthhub.com, there is an MSP Buyer's guide, you know, for when you know that you want to grow your MSP, but you don't know which bits you don't know which service do I, you know, get a consultant, do I join a group? What do I need to do? Go and download it. Go and have a look at it. And it'll help you to work out some of the best support for that MSP and put some of this into context, won't it?

STUART: Absolutely.

IAN: Brilliant. I think we've done this show. I think that's done. That's been a great show. You know.

STUART: There's some key tips in there. You know, pull them out. I think there's seven or eight key tips in there. But it, they're that, they're the things to aim for. The key is now where do I start and how am I going to change? And how am I going to do that consistently? As I say that, you know, those that are really on it. It's probably a three year process for many. It's longer. But it, that's up to you.

IAN: And the answer to that is put a plan together, work the plan, be consistent on the plan, and it'll work. But, you know, to cut that cord. We mentioned it before. You know, and that dependency, you know, while you are huffing and puffing, because you are dependent, the business is dependent on you. That's the time to change.

STUART: It is.

IAN: Great stuff. Thanks Stuart.

STUART: You're welcome.

IAN: Catch you on the next one.

STUART: See you next time.

IAN: Bye bye.

TEASER: In next week's episode of The IT Experts Podcast, we have got a cracking one for you. If you are the bottleneck, if you are trying to work out how the business is so dependent on you and what you need to do about it, then you've got to check it out. It's all around getting you ONN own and not needed, getting you out of the day-to-day delivery, helping you work out what you need to do to get that position where your business does not rely on you as a bottleneck. Check it out next week. I'll see you then.

OUTRO: Oh, but one last thing just before you shoot off. And if you're curious about how this episode links with the ability to scale your MSP to a million or, or if you are already there, accelerate to five, then we want to invite you to come and take the MSP Mastery quiz. And in just three minutes, you're going to get a 360 degrees scan of your business where you can identify the one or two tactics that can help you find more time, engage in, align your people and help generate more leads in your MSP. It's really simple. Just click on the link in the show notes and if you have enjoyed this episode, we'd love to get some feedback from you by means of a rating review on Spotify or iTunes, or your podcast platform of choice. We really appreciate every single one of them. Now, you can go and enjoy the rest of your day and we look forward to catching up and connecting with you soon. All the best day.