Donza Worden from Clear Peak Capital breaks down the different types of MSP buyers and what they mean for your business. Learn about:
- Different buyer types and their approaches
- How private equity views MSPs
- What happens to company culture post-acquisition
- Understanding rollover equity and earn-outs
- How to evaluate potential buyers
Transcript
Steve: [00:00:00]
very quickly, we are a partner. Payment Automation Platform for MSPs. Uh, Baxter probably won’t like how much I simplify this. Uh, but you know how you can sign in and pay your electric and gas bills? Well, we give MSPs a payment portal just like that. So your clients can log in. View past and current invoices, update payment information, set up autopay, and more.
We’ve also got some incredible insights to help you, the MSP, understand your cash flow and other important metrics. Donzo, would you like to take a couple minutes and tell people what Clearpeak Capital is doing?
Donza: Yeah, perfect, and I’ll, uh, I’ll kick it off with the presentation, actually, if that works.
Steve: Sure.
Donza: Can everyone see my screen?
Steve: We can.
Donza: Perfect. So yeah, quick introduction on Clearpeat Capital and who [00:01:00] we are, um, my background is I’ve spent 10 years in private equity. Most recently I had a fund, uh, in New York we had about a billion and a half under capital, and recently launched my own firm, an independent sponsor, along with my co founder Luke, in January of last year.
And so we’ll talk a little bit more about what an independent sponsor is. Fundamentally, we’re, we invest within the IT services landscape. We’ve got four folks at our firm, uh, and then multiple operating executives. Some of you may have heard of Service Leadership. Um, Brian O’Connell’s partnered with us on our MSP strategy and looking to invest.
And, um, in that space, we have one portfolio company looking to do two more acquisitions in 2025, uh, to talk more about that later. But fundamentally, uh, the purpose of this presentation is to, one, articulate a little bit of why are people excited about MSPs? Why are investors excited about, uh, this landscape?
From there, what does the buyer universe look like? And then [00:02:00] lastly, within that buyer universe, what matters? Uh, what questions should you as a potential seller be asking, or I believe you should be asking? And then lastly, how does that manifest itself structurally? And so, starting with just the, the investment thesis in the MSP landscape.
Investors, fundamentally, they’re looking for future free cash flows and that predictability around it. And so, when you’ve got an MSP with this contracted revenue base, it’s growing over time, and there is that pathway, that’s what gets people excited. And so, the investors, fundamentally, they want that visibility, they want to see those contracts and understand that, alright, if you’re doing 10 million in revenue this year, we can guarantee that 9 million, at least, is going to come next year.
and we can build off of that base. Another aspect is, uh, the fact that it’s a very fragmented landscape, and there’s the opportunity for a buy and build. And so, uh, colloquially a lot of [00:03:00] people talk about 1 plus 1 equals 3, um, or some form and fashion of that. What it really means is that the sum of the parts, when you take one MSP and take another MSP, bringing those together is fundamentally more valuable than individually.
And that manifests itself through kind of three avenues. One avenue is just you now have a better, a more diverse base of clients. And so previously if you have one MSP and they have 50 percent of the revenue in one client, You can buy it with another one, uh, that concentration goes down and it’s a less risky investment so to speak.
Uh, the other aspect is synergies. And so when someone buys your company, they’re looking at both bottom line, so cost cutting, and that’s what you hear about with private equity all the time, uh, but also revenue synergies. And I think that’s what’s more exciting and really more realistic within the landscape.
What you’ll see is, in the MSP world Say you, you buy an MSP that’s providing just managed devices, IT helpdesk, [00:04:00] to, to a hundred clients. Uh, the, the exciting aspect from an investor’s base is if you can buy that MSP and you have a security offering, or you have an Azure offering and they’re, everyone’s on prem, but you can convert them to the cloud.
You then take that existing customer base and you sell further services and products into it. And so, Go ahead, Steve.
Steve: No, I was, I was just going to say, so it’s, it sounds like, um, you know, let’s, I’m going to name names. So when Kaseya gobbles up another MSP platform, right, uh, their main goal is to start cross selling that to their existing customers.
Um, it, it almost sounds like what you’re saying is, uh, a lot of times. MSPs will find ways to cross sell their, uh, different services to their existing customers. Simplifying it, right?
Donza: That’s, that’s the goal. Uh, generating more cash [00:05:00] flow from those two entities, uh, combined versus individually is the goal.
And you can accomplish that through selling more services through it. Uh, there’s the entire aspect of you only need one CEO, you only need one CFO. That type of thing as well. And so it’s fundamentally, how do you, how do you increase the cash flow of these two entities when you bring them together?
That’s, that’s the main goal of it. Um, and that’s what allows for kind of the buy and build process to work. It’s generating kind of more cash flow by bringing them together. Additionally, there’s obviously less risk associated with those if you just bring them together. So if you did nothing else, if you brought ten companies together, And you brought them all under one roof, nothing changed.
That’s a more valuable entity because there’s less concentration of cash flows within that bigger organization. So does that, does that broadly make sense, Steve?
Steve: It does. It absolutely does.
Donza: And so, that’s, that’s [00:06:00] why there is so much investor appetite within the MSP landscape is that you can bring a lot of these together and you can create a lot of value by having this bigger organization and this bigger entity, coupled with just the inherent nature of the MSP revenue model, which is contracted, predictable, predictable.
Um, and you look at kind of the, the outsourcing trends as well as just the, the fundamental growth drivers within the IT industry. All of that creates an attractive asset class, so to speak, and is what has garnered interest amongst, uh, a pretty big universe of buyers. That universe of buyers, we’ve, uh, effectively kind of categorized it across these five lanes.
You have strategics. Strategic is really characterized by, they have an existing MSP. Um, you need to broaden that really to, they have an existing asset within IT services, or they want to get into the MSP space. Uh, but really it’s, they don’t have an institutional backing is how [00:07:00] we, we, uh, look at it.
You’ve got private equity backed strategics. Um, private equity backed strategics just means that they have a. A private equity firm that has funded them. And maybe just pausing a bit on what is private equity? Private equity is fundamentally, it’s a pool of capital, um, that a general partner’s invest to generate a return.
That pool of capital is coming from pensions funds, uh, family offices, high net worth individuals. They’re giving that money to investors to then buy companies, and hopefully they buy those companies, and then they sell them for more than they bought them for. And that’s what generates a return. And so, as a part of that entire process, generating that return is what matters.
Uh, and how they do that is what’s really the difference between private equity funds.
Steve: All right.
Donza: Go ahead, Steve.
Steve: Sorry, I, I always thought of private equity as high net worth individuals. I never [00:08:00] even thought about, you know, pensions and, and other, other pools of cash.
Donza: Yeah. So that, so it’s primarily endowments, uh, pension funds, uh, big insurance agencies.
And so, high net worth individuals and family offices is probably, is a minority of the capital that’s allocated to the space. Um, you’ve got Texas teachers, New York State teachers, fire departments, um, police departments, all of that on a state basis. Those have pension funds, they allocate that. You’ve got universities, they’re allocating that to the asset class of private equity.
And that’s a bolt of the assets, really.
They’re, uh, think of those across two lenses, uh, one is, is it a private equity backed strategic? And so that just means that a strategic company, uh, or a company within the MSP space is owned by a private equity fund, and they’re looking to do add on [00:09:00] acquisitions. The other is, is it a private equity kind of platform investment?
That means the private equity firm is going directly to you, the MSP, and saying we want to build out an MSP investment and, um, most likely do an M& A strategy around it. Uh, another category, uh, broadly are independent sponsors and searchers, so independent sponsors. Very similar to private equity, but they raise on a deal by deal basis.
So private equity, you have a committed fund, they raise 200 million, they then have the discretion within that fund to buy assets, um, as the GP decides. With an independent sponsor, you’re finding a deal within your investment thesis, uh, and we’re an independent sponsor, uh, you find a deal within your investment thesis, and then you raise capital from a network of individuals, a network of capital providers, Uh, on a deal by deal basis.
Lastly is [00:10:00] searchers. Searchers are probably best characterized by they’re coming into the company and they’re looking to do a full buyout of that company, uh, and ultimately run and manage it. Um, so those are, those are effectively the five categories. I think it’s important to dissect them a bit more, um, and really understand, I think, to really understand them, you have to understand what is their source of capital, um, and how are they thinking about a transaction.
And so, within just kind of taking them, um, as well, strategics, if they don’t have an institutional backing like a private equity fund, they’re typically funding your transaction with the midst of debt and or cash on hand, um, and that, that provides, that provides different dynamics. And what I mean by that is who’s really making the decisions, is that they have to go and raise debt for this deal, then the bank and getting the bank involved, that’s going to be kind of a key decision maker.[00:11:00]
Within private equity backed strategics, there’s equity coming from the fund. The important part there is to understand what fund has invested in the MSP. And so you have this private equity kind of monolith of like, alright, this is private equity XYZ firm. Within that firm there’s fund 1, there’s fund 2, there’s fund 3, there’s fund 5, what have you.
If the MSP investment is in Fund 3, what you want to understand is how much money do they have actually to allocate to new deals. And so you look at how long has that investment been in the portfolio, how long, how old is it? All of those are factors that you should be thinking about and considering because that determines kind of their legitimacy and their ability to kind of pay.
When you’re dealing with a private equity backed strategic, you’re typically talking to the VP of business development. We’re talking to the C suite, sometimes the PE professionals will get involved, but a lot of times it’s concentrated at the portfolio [00:12:00] company. Fundamentally though, uh, what’s interesting is in a private equity backed strategic, really the partner and really the managing partner of the firm is the one signing, signing off on the deal.
Even if you’ve never met them, fundamentally, they’re the ones signing the check, um, in that regard.
Baxter: Danza, I’m super familiar with on the PE backed strategics, I mean, there are obviously a ton of them. Contiva, Miraplex, Evergreen. What’s an example of like, strategics in this space who are, and maybe there are strategics that I’m familiar with that I just are not, don’t have current private equity backing?
Donza: Yeah, so I think of strategics on the, probably on the smaller side. Um, and so I’m not thinking of a firm that has 500 million in revenue and is, or a multi billion dollar public entity, which is pretty similar. I’m thinking more of a Your buddy’s been in the MSP industry for [00:13:00] 20 years, has done five acquisitions, um, each of them are 200, 000, 300, 000, uh, in revenue.
And so, it’s more of a kind of, the MSP landscape’s pretty interesting in that regard, in that you have, M& A has always been a component within it. And previously, before private equity, it was the more entrepreneurial folk who were leveraging their balance sheet, taking on debt, taking on cash on hand, or individual investors.
Baxter: Yeah, there’s a, there’s a great guy who I know named Sean Torres, who runs a company called Intellicom. It’s based in the Southeast, and so he’s started his MSP from square one, grown it, and acquired I think two other MSPs, so I guess that’s, that’s the strategic camp, assuming that he maintains ownership and is just utilizing a bank to obviously fund that transaction.
Makes sense.
Donza: Exactly. Yeah, I think that’s a perfect example of what I’m thinking about within the MSP realm. Um, every industry is obviously very different. [00:14:00] Um, then there’s the bucket of private equity, uh, and private equity coming in, they’re coming in looking at it as a platform investment. And so that’s a very, that’s a very different lens than if it’s a private equity backed strategic.
What I mean by that is, They’re looking to back the management team. They’re looking to back the bones of of the company effectively and and grow from there And almost every MSP deal M& A is a pretty core component to the growth thesis And so they’re looking to do fairly high velocity M& A to hit their return thresholds Um, they’re funding that from the latest fund, and so when I go back to, you looked at a private equity firm, they have multiple funds, the latest fund raised is what’s ultimately making this investment.
And as you, the MSP seller, you’ll typically be, uh, depending on the size, you’ll be interfacing with the associate, the VP, the principal, the partner, [00:15:00] uh, at the private equity firm. But fundamentally, the managing partner or the founder is the one that makes the decisions within that organization. And so, you’ve got various, various private equity funds and every private equity funds run a little bit differently.
But the, uh, the better one, so to speak, they enable the partners, they enable the, the principals and such to, uh, Be the voice of the managing partner. And so you may never even talk to the managing partner, the person that’s actually signing the checks, but you still get to the same spot. Within independent sponsors, again, that’s effectively who we are.
We’re a little bit different than private equity. A lot of times, and what our pitch is, as opposed to within private equity, you’re really reporting into Reporting into a board of directors. There’s monthly ops calls, there’s quarterly board meetings and stuff like that. Our model is to, uh, be an augmentation of the management team.
And so we’re augmenting the team. We see [00:16:00] ourselves, uh, within the company as opposed to having the CEO and the founder report to us. It’s how do we facilitate and help them make better decisions, um, and take things off their plate. And so it’s a little bit of a different model, a little bit more concentrated, uh, in that regard.
And going back to that point, within a private equity firm, a managing partner could be on the board of 15 companies. Within an independent sponsor, you’re looking at 3, 4, 5 max. Um, but it is on a deal by deal basis, and so when you’re evaluating, uh, an independent sponsor, you want to understand, have they done a deal before?
Have they, do they have access to capital? Who are they talking to? Um, do they have, uh, Do they have connections within the family office space? Do they have connections within the SBIC space to be able to fund those deals? And so that’s an important aspect of, um, of it all. Lastly, searchers, uh, again, the best, the characteristic there is they’re typically, they are [00:17:00] definitionally taking over as the CEO, uh, or taking over explicitly within the management team.
Uh, they typically use SBA debt, uh, they’ll have a personal guarantee on that debt, and they’re taking out, uh, a majority of the equity. And so, the reason why I wanted to spend time a little bit on the structure of these entities is because ultimately it impacts, it impacts what’s, what they can do, uh, and what I mean by that is, uh, we really think about it of, as an owner of an MSP, uh, how do you think about post closed control?
How do you think about the upfront cash that you’re getting within a transaction? How do you think about the second byte opportunity? The second byte opportunity is really just a colloquial term for you have rollover equity that you still have equity in your company, and it could be worth more on the subsequent sale.
And then there’s also certainty to close. Before I go into that, Steve, any, any questions, comments on [00:18:00] the buyer landscape for this?
Steve: I, I have some questions, um, but feel free to tell me to wait if, if it’s something you’re going to cover later. So, my first question is, can we go back to that last slide? When, when looking at these different buyer personas, are they looking How do I, how do I phrase this correctly?
Are, are they looking for something different, each of them? Like, for example, some of these might be looking to build, like, a platform where, uh, you know, like something like the 20, right? And then some of them may just be interested in acquiring a couple strategic locations to expand their reach while others are trying to, you know, dominate the world.
Um, So, so I’d love to understand, like, how each of these might think [00:19:00] strategically, not to be confused with strategics, and then also, uh, I would love to understand, um, and this is probably a more nuanced question, what, what each of these may mean for The Current Company Culture, uh, Team Assets, etc.
Donza: So for that last question, I’ll defer that to the next slide.
Um, but, but your first question on kind of what is, what are they looking for? Uh, it goes back to really understanding kind of the source of capital. And what I mean by that is, If you have a private equity firm that’s looking to deploy 50 million or 100 million into a specific deal and those are the types of questions you should ask as an MSP seller.
If they’re looking to deploy that amount of capital into a specific MSP company, then they either have to start very big [00:20:00] as a platform or they have to do a lot of M& A. And so the people that are, are, are doing a lot of acquisitions, um, and I don’t know the scale of them exactly, but they’re looking to deploy a certain amount of money within the strategy.
Uh, and so that’s what’s making them do 10, different deals. Uh, a strategic, as we’ve defined here, They’re probably going to be a little bit more, uh, thoughtful, slower, uh, and it goes back to kind of, are they building out a couple services here, uh, and being, uh, lower velocity. Uh, it’s probably similar to independent sponsors and searchers as well.
Again, uh, everything funnels from, uh, source of capital and your access to capital, uh, and, uh, Private equity, they’re allocating uh a chunk of it, and that’s what’s going to dictate the velocity. And so going back to our private equity back strategic, if the private equity firm has been in the company [00:21:00] for five years or eight years, the pace of with which they do M& A was going to slow down most likely, As it gets to years 10, or they’ve already sold a subsequent time.
And so what happens is then, if you remember, private equity, they’re ultimately looking to generate returns within these deals. So they buy a company, they then do a bunch of M& A, they get that 1 plus 1 equals 3, hopefully, and then they sell it to another, potentially private equity firm, um, goes public, or what have you.
And so, Hopefully that helps clarify it. Again, I’m trying to provide like concepts that allow you to, to rep, it’s not a, not as cut and dry as how do you ask the question if you’re approached by one of these parties, uh, what is their strategy, um, and what’s dictating really that strategy.
Baxter: Yeah. And I think that, Donza you hit the nail on the head with that last point, which is.
There are obviously broad, overarching concepts of where strategics spend their [00:22:00] time and what they’re looking for relative to private equity backed strategics, relative to private equity firms that are looking for a platform. But I think the, the note for MSPs that’s super important is just understanding what is their goal as part of the transaction.
Where are their, where do their incentives lie? What are they trying to create? Do they just care about a return? You know, in three to five years, do they plan on holding the company for 10 years? You know, all of these questions, you know, I think in the, in the landscape today, um, based on a lot of, uh, M& A MSP space that I’ve listened to, you know, everybody’s calling it reverse diligence and making sure that you’re doing diligence on your buyer while they’re also obviously doing diligence on your business.
Donza: Yeah, I think that’s exactly well said, and there’s a lot of different ways to make money within this space, and I don’t profess to think that there’s [00:23:00] only one way. And so, you can make money by having uh twenty disaggregated MSP satellite offices that still maintain their entire brand, and you can make money by having a fully integrated uh twenty deals that are now operating under one brand, one complete backed office.
One complete centralized ticketing system, uh, as well. I think, uh, we personally have a preference, um, on what we think works, but fundamentally, you can make money a variety of different ways. It’s, do you align with the culture? Do you align with, uh, what the private equity backed strategic, private equity firm strategic, any of these buyers are ultimately saying to you.
Um, and then it gets back to peeling back the onion of what are their incentives, um, and that’s a function a lot of times of the capital, the duration of that capital, the cost of that capital, uh, as well. [00:24:00] Going back to, um, what’s, what dictates, uh, what matters to you, uh, in this whole, this concept of, uh, reverse diligence.
There’s really two, two reasons that, from my point of view, why reverse diligence matters. Uh, is that you care about your legacy, you care about the culture of the company, and you want that maintained in some form or fashion. Um, and so that, that requires you to have, uh, to do reverse diligence. Just as importantly is, if you believe in your company, you believe in what you’ve built, and bringing on a partner is additive, then you want to understand what that next second bite, so to speak, is potentially worth.
And so, when I think about when I’m, if I’m in your seat, and I’m looking at MSP buyer landscape, I’m really asking, the first thing I’m doing is asking the question, asking these questions. Do I want post closed control? Do I really care about the culture? Or most [00:25:00] people are generally good, it’s not gonna be that bad, so I don’t care that much.
Uh, do I want to have equity in this go forward ownership? And I had access to money and more resources, 10 times. Um, I want to take a risk on certainty to close, that type of thing, um, there’s trade offs along the way. Um, I don’t know if I need to go through kind of each one of these, Steve, but, uh, I happen to dive into any one of them.
I tried to kind of lay out a landscape here of generally what occurs, um, and again, if you, if you truly understand kind of the landscape here, these become a bit self evident. Um, And I’ll take like the second bite opportunity. If you’re, if you’re a platform investment and you’re the first deal by that private equity firm, then your upside is going to be greater most likely than if you’re coming in on year [00:26:00] six, uh, you’re one of 20 acquisitions, and they’re saying you need to roll 30 40%, the value of that 30 40 percent rollover when they do a subsequent sale.
is most likely going to be less than if you were the kind of the platform investment or partner with an independent sponsor, so to speak. Again, everything is very much a generality. Uh, there is, everything needs to be looked at in specificity to really make an informed decision. Uh, but I think this general kind of, uh, landscape is probably generally right.
Baxter: I think the other, the other piece, right, is, is, And I think a lot of people do this, which is, you know, they wait these different items for them specifically. So the certainty to close and going through the diligence process mean is it 50 percent of your calculus is the second byte opportunity, 25 percent of your calculus is the upfront cash, 20 percent of your calculus.[00:27:00]
Um, you know, there’s also, you know, team, uh, Steve mentioned this. Which kind of fits into the post close control, which is kind of culture and team, right? And how much do you want to ensure that the employees who’ve worked for you for the last 10, 5, 10, 20 years feel good about the decision? You know, obviously that’s something that I feel strongly about, but, you know, I don’t run an MSP, uh, and everybody’s, you know, decision may be different, and it’s a personal decision, obviously.
Donza: Nope, I think, I think well said, and there’s, it’s not, it’s not a zero sum here, um, you could, you could sell to a strategic and lose a ton of control, but completely, completely jive with their culture, and be like, wow, we’re, we’re gonna be in good hands. You could sell to a private equity firm, be in control, think that you’re fully aligned on the culture, and two years from now, everything gets upended.
[00:28:00] And so, it’s all, it’s all about you, you need to build a relationship with the party on the other side of the table. Uh, and you need to understand their incentive structure, why they’re doing what they’re doing. Um, this kind of balances those two out. And then, ultimately, what, what matters to, to you all.
Um, This is a little bit number heavy and complicated, uh, but really, when you an when you ask these questions, uh, you’re gonna, what’s important to you, this is your universe of buyers that ultimately could deliver, but then how does that manifest itself structurally? Like, what does that really mean? And so if you care about the second byte opportunity, What that means is you want more rollover equity, or you’re okay with an earn out, or a sell earn out.
That just means you now have consideration in this go forward entity. And so, um, yeah, recommendation is you, you, you do get a good investment banker, you get a good lawyer, [00:29:00] uh, to work through all these things. But I think once you, once you have an idea of what’s important to What is the universe of buyers?
Then it’s alright, how do I structure a deal, uh, to accomplish those goals? Uh, the easiest one is, uh, everyone gets some type of cash consideration. Well, not everyone. There’s cash consideration, uh, and then from there, I’ll say there’s this other tranche of this second byte opportunity. Second byte opportunity is a mix of rollover equity in the new entity, You’ve got earnouts, uh, contingent payments, basically, if you achieve certain, uh, certain goals.
Uh, and then a seller notes, basically, uh, a fixed income instrument as well. Um, a deal, quite frankly, can be structured in, uh, as many ways as you can come up with. Uh, and it’s a little bit just about the, the creativity and, and solving everyone’s objectives. As an investor, I’m looking to minimize my risk, uh, and maximize my return.
And to do that, [00:30:00] a lot of times it’s, there’s alignment as a seller. If you’re telling me that you can double EBITDA in one year. Then how do I ensure, incentivize you to do that? Uh, and so it’s a, it’s a push pull between the buyer and seller, um, as well.
Baxter: And, and I think this is where like a lot of the complexity comes into play.
And the other thing is everybody, I think, outside in thinks about these deals as a multiple, right? Like, all right, how much are MSPs trading for in the market? I think generally people say. You know, if it’s a platform, it’s over 10, you know, maybe 13, 15 times plus potentially, depending on, uh, the size and scale and industry verticalization.
How much does a single smaller MSP trade for generally? I think people are saying six to eight, but when you unpack some of those numbers, the devil’s in the [00:31:00] details as to how much cash is the owner taking off the table at close. Right. Is there an earn out structure in that deal? So if they double the business, does the owner make more money or is there no earn out structure?
Is the owner taking a certain number of his, of the, of the company value and rolling it in equity into the new entity to take the form of that kind of second bite of the opportunity? You know, or some owners are just taking, uh, basically, I mean, a seller note is basically an IOU, um, for, uh, future yield on the seller note, right?
And so, some deals could be structured as, you know, A hundred percent of a seller note, but the company just got bought for 12 times EBITDA. Uh, if you look at the 12 times EBITDA, it sounds like, you know, the owner just made out like a bandit. But if you’re [00:32:00] now getting paid as a seller note, and there’s uncertainty to making all those seller note payments over the next five years, let’s say, It’s obviously not the exact outcome that maybe the owner had wanted, um, and you know, this happens a lot in all different industries when, you know, a software company announces an acquisition or an MSP announces an acquisition, you know, I think the face value is always obscured by, uh, the underlying details that are not public information.
Donza: Yeah, and it’s even as simple as, if you have, say this is an example seller, um, and they’ve got 10 million of rollover, if you believe because of the team you’re partnering with, uh, is really going to be able to effectuate change within your company, then that rollover equity could be worth significantly more than just kind of that headline price.
And so, thinking [00:33:00] about it, the day one closed, um, everyone’s happy, everyone wants to see a large number hit their bank account, but if, uh, a lot of private equity firms and in pen sponsors and folks in that realm, they want to partner, they want to partner with the team as is. And so, and, you know, You as the team, do you jive culturally, do you jive intellectually, and believe that they can really drive value?
That’s just ads are more important than a headline price. So I’m a seller and I see I have a bid for 55 million, but this other group, and both of them are asking you to roll over 30%, Then you have to make a decision. Is that 30 percent going to be worth significantly more under this group? And I’ll take 5 million less today to get 20 million more in four to five years.
Just all part of the calculus, so to speak.
Steve: I have probably a dumb question. This [00:34:00] is not the first time you’ve said it, Baxter. Uh, you’ve said it before where you’ve said the calculus, and I always assume you mean calculation and you’re misspeaking. I know you both were talking about the calculus, and I’m very confused.
Baxter: No, I never took, I never took calculus in college, because I couldn’t, couldn’t get through pre calculus.
So,
Donza: uh, I just started to
Baxter: sound smarter.
Donza: Yeah, finance people trying to sound smarter than they are. Uh, it’s really just basic arithmetic. Uh, if we’re doing anything more than multiplication, we’re probably doing something wrong.
Steve: That’s hilarious.
Donza: It’s good call out. I like that. Shouldn’t use it. It’s the same as one plus one equals three.
I don’t like that saying, but it’s, uh, industry wide.
Steve: Um,
Baxter: Steve, any other questions that you think would be, uh, would be helpful for the group?
Steve: So, um, [00:35:00] I’ll, I’ll be honest, I, uh, when I look at this, so cash to seller, that makes sense. Rollover makes sense. What I’m a little confused on is I’m looking at that second column. Earn out. Is that, that’s, uh, something that gets paid to the former owner.
Uh, years down the line, if things are going well, correct?
Donza: Yes, with well being a very generalized term and meaning anything. So you can put in an agreement that well is defined as XYZ employee stays with the company or XY EBITDA is 10 million or revenue is 100 million. And so it’s a, it’s any parameter you want.
Um, it’s basically saying that in the future, the company has delivered X. Click through rate,
Steve: The RocketMSP [00:36:00] Podcast, Comet
Donza: Backup, NaviStack, MSPs, Channel Program, vCIO, owes the seller 5 million, um, and they’re going to pay out 8 percent a year to that.
Baxter: I think it’s a good point though, Steve. And I was going to use calculus, but I’ll, I’ll, I’ll say math from now on.
Um, the sources and uses is kind of a private equity kind of technical term in a way, but all it’s saying is where is the money coming from and where is the money going. The money going is really what the current MSP owner should be thinking about, which is how much cash is going to hit my bank account on day one, which is the 30 million in this example.
How much of the ownership company, ownership stake in my business is going to be rolled over into the new entity, and hopefully I’m making [00:37:00] an investment in the new company. And then, based on some sort of milestone, you know, it could be EBITDA, it could be revenue, it could be me staying with the company, I have a future potential payout of 5 million.
And then there’s this debt instrument, which is the IOU, um, of another five million dollars, which also could pay out, um, a cash yield on, right? So it could pay an interest rate on the five million of like ten percent, uh, but it would also again be paid at a future future year, future month, and then the fees and the expenses are obviously legal fees, banker fees, broker fees, diligence fees, you know, the list kind of goes on.
And so, you know, this is one of the key things I think that everybody needs to consider on the MSP side is when you look at, okay, my MSP is doing five million dollars, I’m [00:38:00] selling it for 10 times EBITDA, so it’s a 50 million acquisition, but on day one, I’m only receiving 30 million of cash, and then, you know, there are these other question marks as to, do I believe in the buyer?
Do I believe in the game plan? Do I believe in the future strategy of this business? And some of those numbers you may want to discount, or you may actually believe that if I roll over, if I make a $10 million investment in the new company, that may be worth $20 million or $30 million, or, you know, even, even $60 million.
I mean, some of these MSP, um, you know, private equity backed strategics. I know really, really focus on, you know, their track record in making MSP owners much more wealthy based [00:39:00] off of the rollover equity as opposed to the actual cash at close.
Donza: Yep, I think, very well said. I agree with everything.
Steve: And, you know, the rollover equity, I mean, let’s be honest, that’s, that’s a great incentive across the board, whether it’s, uh, to incentivize the seller to stay on board, um, or to, you know, Or just to, you know, because I guess the way I look at it is, if, if I’m going to stay on board, I, I still want to have some skin in the game.
So that rollover equity is phenomenal. But if I’m just looking to sell my MSP and, and go retire on a beach and sip mojitos somewhere, you know, maybe the rollover equity isn’t something that I care about.
Donza: Well, I think even in that, Yeah, as I say, even in that scenario, you could still care about it, [00:40:00] because if you believe in the business you’ve built, you believe in the partners that you have, you go sit, sit on the beach, sip your Mai Tais, that, that’s going to achieve a greater return than just putting that 10 million in the stock market, right?
If you’re, you’re, you’re now just came into 30 million of cash, and you’ve got this 10 million that can be in the company that you helped build, or you can put it in the S& P 500, right? A lot of times it’s you want the former and as an investor, if you don’t want the former and you’re like, no, I’d rather put in the S& P 500, it raises questions from our point of view.
It’s like, well, is there, are we missing something? Um, and it could be a totally rational reason why you want that 10 million out of it. Uh, but it’s certainly from an investor’s point of view, it gives us more confidence that you’re aligned, you’re incentivized and you have skin in the game to make this successful.
Even if you’re on the beach. Um. You still means that everything you represented as to what the company is, you feel good enough that between our vision [00:41:00] and what you’ve already built, it’s starting to be a better return.
Baxter: Yeah. And there’s a lot of, there’s a lot of complexity in each one of these items.
You know, the, the challenge, there are pros and cons and you could probably do a, at least an hour session on, on each one. Um, you know, one of the things that I, that I find really interesting that’s happened recently in the market with a big name. is Evergreen, right? So Evergreen has done very, very well.
They’ve acquired a lot of MSPs. They do utilize rollover equity for a lot of those businesses that they’ve acquired. Um, but instead of selling Evergreen, as the fund has expired at Alpine Investors, which is the private equity fund that backs Evergreen, they created a continuation vehicle, which allows them to hold on to the company.
For even, even longer. So, I’m sure a lot of MSP owners who rolled over equity in 2018 or 2019 or [00:42:00] 2020, you know, thought that they’d get their investment back, which I think is, I’m sure it’s made money in 2023 or 2024, but now they’re probably going to be waiting, you know, another five years until they actually monetize and liquidate that rollover equity.
So, you know, timing is also another really important concept of You know, when are you going to actually be able to monetize the future, uh, potential, you know, uses or cash flows here?
Steve: That makes perfect sense. A lot to digest. Yeah. Don’s eye for, oh, I’m sorry. Go ahead.
Donza: No, I was going to say, I agree. There’s a, there’s a lot of nuance behind each of these and, uh, it is a lot to digest, but, uh, enjoy, enjoy the conversation.
Steve: Yeah, so can we talk about company culture for, for [00:43:00] a minute? Um, typically when an MSP is acquired, like, you know, by a strategics or even private equity backed strategic, um, it’s being acquired by Buy, typically, an MSP, right?
So, that seems easy enough for, for two MSPs to kind of come together and figure out how to bridge their culture together. But when you start looking at companies like yours, independent sponsors and searchers, um, how does, how does that really affect company culture? Because, aren’t you Um, aren’t, aren’t you looking for larger MSPs to acquire at that point?
Or, or are you looking at a bunch of small to medium MSPs to, to bond together? [00:44:00] Like what’s, what’s kind of the play here?
Donza: Yeah, so I think you could probably bifurcate the page between strategics and private equity backed strategics and then everything to the right of it. And so, on the left, it’s like what you said, Steve, they’re bringing them in, they’re subsuming them in some form or fashion, and each culture is different.
Maybe when you subsume another MSP, it means that It’s your own entity in this geography, nothing changes except for now you have to use ConnectWise or something. Um, that’s, they’re going to have a defined road map though on what culture and integration looks like. Everything to the right, private equity, independent sponsors, searchers, it’s really Wild, Wild West.
Like, there is no, there’s no defined playbook of X, Y, Z, private, if private equity comes into your company, what happens to the culture? It’s much too general of a term, uh, or general of a concept to, to really have a definitive point of view. I would say, generally though, you’re partnering with the [00:45:00] team, you’re partnering with the individuals that have already created a successful organization.
And so, we’re coming in as investors, evaluating your company, and we like it, and we see it, and everything you’ve done is great. And we’re looking to probably accelerate it, um, but day one, uh, it’s not a novel concept, but I would say it. Almost everyone on this list, day one, they’re going to say, don’t break anything.
Nothing changes. Uh, because fundamentally, we’re backing the company that’s gotten you, gotten to this point. And over time, I would say, you’ll see a probably injection into the culture around, uh, accountability and meritocracy, um, is probably, probably a, somewhat of a defining characteristic as financial people get in there, um, and so more data driven type decision making, um, but again, that, the rule of thumb, and it’s not a [00:46:00] novel rule and I’m guaranteed everyone would, most everyone would say it is, you don’t want to break anything.
You’re partnering with the company because of what they’ve done already today. Uh, and then from there is how do you optimize and build around it?
Steve: Okay.
Very good. Um, are there, are there more slides?
Donza: There’s no more slides. We only got, we got six slides.
Steve: All right. We did it. Perfect. Baxter, is there anything else that you feel we need to go over?
Baxter: No, I thought this was, I thought this was great, Danza. I really appreciate, appreciate you joining. Appreciate everybody joining.
Um, next Office Hours is in two weeks. Yeah,
Steve: next, uh, the next Office Hours is on February 6th with Hannah Page, Workland.
Baxter: Awesome. We’ll see you there, everybody. [00:47:00] Appreciate the time and, uh, have a great rest of the day. Thank you, Danza. Cool. Thanks everyone.
Steve: Thanks everyone. Take care.
