MSP Valuation Secrets: How to Maximize EBITDA Multiples for Your Exit
Building an Investment-Grade MSP: A Masterclass with Reed Warren
Most MSP owners view their business through the lens of daily operations, but Reed Warren, President and CEO of IT Valuations, argues that true success comes from viewing your company as a high-performing investment vehicle. In this deep dive, we move beyond surface-level growth to explore the "Company-Specific Risk Factors" that professional buyers use to determine your actual worth. Reed shares a decade and a half of M&A expertise to explain why a "win-win" transaction is the only sustainable path to an exit and how the "Rule of 40" provides a definitive benchmark for your operational efficiency.
This session isn't just about preparing for a sale—it’s about building a market-resilient firm that can handle economic downturns with ease. From the nuances of "corporate hygiene" and contract assignability to the strategic necessity of owner independence, this episode outlines the exact financial dials you need to turn to maximize your valuation long before you ever reach the letter of intent.
What You Will Learn in This Episode
00:00 – Intro: Reed Warren and the "Win-Win" M&A Philosophy
01:32 – The Importance of Early Transformational Planning
03:00 – Engaging with the MSP Community and Peer Groups
04:18 – Why Every Owner is an Investor in Their Own Business
05:40 – Market Resiliency: 5% EBITDA vs. 20% EBITDA
07:30 – Why You Need a Valuation Even if You Aren't Selling
08:30 – The Two Elements of Value: Multiples and EBITDA
09:50 – Using Acquisitions to Drive 50% of Your Growth
12:21 – Glossary of Terms: What is a "Multiple"?
14:30 – Company-Specific Risk Factors vs. Industry Averages
16:55 – Top Driver of Value: Why Growth Rate is King
18:37 – Explaining the "Rule of 40" for Operational Efficiency
20:45 – The "Sweet Spot" for Recurring Revenue (65%–70%)
23:15 – Don't Leave Money on the Table: Projects and Products
24:34 – Benchmarking Gross Margins: Managed Services vs. SaaS
28:10 – The Truth About Hardware Margins and SG&A
30:50 – Confidence in Pricing: How to Get a Rate Increase
32:15 – Organic Growth: Net Revenue Expansion Strategies
33:23 – The Role of Account Management in Protecting Revenue
34:37 – Why the Owner Should Quit Selling
37:33 – M&A Readiness: Consents vs. Assignments in Contracts
41:31 – Cleaning Up "Corporate Hygiene" and Operating Agreements
44:08 – R&D Tax Credits and Intellectual Property Rights
47:01 – Due Diligence: Insurance, Liens, and Hidden Liabilities
51:03 – The M&A Marathon: Preparing for the Sprint to Close
53:46 – Owner Dependency: Can You Take a 6-Week Vacation?
59:08 – Reed Warren’s Top Business Book Recommendations
1:03:14 – The $400,000 Mistake: A M&A Horror Story
Resources Mentioned
Guest: Reed Warren
Company: IT Valuations
Books:
Managing the Professional Services Firm
Deep Dive: Removing the Mystery from MSP Valuations
What is a Multiple?: Understand how EBITDA and revenue multiples are used for comparative analysis in the MSP space.
The Rule of 40: Learn how to balance growth and profitability to achieve an operationally efficient organization.
Driving High Valuation: Discover the 26 risk factors, including contract length and customer churn, that impact your transaction value.
Revenue Mix Strategies: Why maintaining 65% to 70% recurring revenue is the "sweet spot" for maximizing both EBITDA and multiples.
M&A Readiness & Due Diligence: Practical advice on "corporate hygiene," including assignability in contracts and resolving hidden liens before you go to market.
Owner Dependency: How to delegate effectively so your business can thrive without you, making it more attractive to investors
Dive Into More Videos
Ready to stop reacting and start leading? If you found Reed’s insights on EBITDA and MSP valuations helpful, subscribe to the How to MSP channel for more deep dives into the business of managed services.
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Reed Warren (00:06)
If it's not a win-win, M &A is one of those categories, so it's either win-win or it's a lose-lose. There's not one's a winner, one's a loser. And so if it's not gonna be a win for the seller, then it's not gonna be a win for the buyer, and neither party should do it.
Andrew Moore (00:18)
That was Reed Warren. Reed is the president and CEO of IT Valuations.
Reed has over 30 years experience in the technology services space as a certified valuation analyst. has aided in different transactions across 19 countries serving over 700 clients. Today we're honored to have Reed on the show as he talks about what is a multiple? How do you get the most value for MSP? What does it look like when you're trying to sell your company? What do you need to be prepared for?
what financial variables make the most impact on the value of your business and allow you to be able to weather financial issues that you find in the market. Reed is full of knowledge and experience and we're excited to see what he has to say.
Andrew Moore (01:04)
Good morning, everyone. This is Andrew Moore, and I am here with Reed Warren with IT Valuations. And we are going to be talking today about driving value within your MSP, building a valuable MSP, ⁓ looking at EBITDA, finding out what makes people want to buy a business, what makes it valuable, how can get people to invest in your organization. So ⁓ hey, Reed, how are you today?
Reed Warren (01:32)
Hey, super glad. And Andrew, thanks so much for having us on the channel here with you guys. Really love what you're building here. Love your background and history, your passion for the market and passion for seeing companies transform and just grateful to be on that journey with you. I think from that perspective, we're really well aligned.
There are so many companies that need help in that transformational journey and they usually don't think about it until late in the game and the earlier you start, the better off you are. And so really grateful for the work that you're doing and it just really spot on for so many people.
Andrew Moore (02:05)
Now I appreciate that. again, like, thank you. You're You're you're you're now you're now my hype man. I will take you with me on every journey I go on. So thank you. So Reed, where are you today? Where does the podcast find you physically? Where are you at?
Reed Warren (02:09)
That's it. ⁓
Yeah,
home in Minneapolis, at least for the time being. And usually I prefer not to be the center point of, hey, the U.S. and what everybody's talking about. anyways,
Andrew Moore (02:28)
Yeah.
Reed Warren (02:29)
That's where we operate out of and it's a great place. I think from that perspective for just running the business, probably 90 % of our now actually 98 % of our client base is outside of Minnesota. So it's a great hub to work from and sort of the centrally located so.
Andrew Moore (02:44)
And you are you are a road warrior of ⁓ all sorts for the MSP community. So if people haven't seen read on the Internet, ⁓ you probably have seen him or his organization at just about every show. So you're going you were just mentioning, like, so you're at Robin, where are you going to be out the next few weeks?
Reed Warren (03:00)
Yes,
be at TMT or Robin Robbins, ⁓ the marketing toolkit, their producers club, that'll be next week in Vegas. ⁓ We'll be at the PAX 8 peer groups. We do just do a lot of work with peer groups and then also at Evolve, ⁓ at the Evolve peer group. So those are probably the three peer groups that we're most engaged in. We used to do quite a bit with Taylor Business Group, ⁓ but then... ⁓
probably less so down the Kaseya channel, although that's been growing, certainly as Robin Robbins has been acquired by Kaseya and that whole journey has been going on. ⁓ Just really feel like that's probably the best environment for us to work in, predominantly because MSPs are getting together in those environments, really talk about, can I do to change my business, how to become a better business? I would just say a lot of what we do is bring out
Objectivity to it. So just real quick on my background spent the last really 16 years doing valuations mergers acquisitions within the IT services Market now think pushing through about 105 transactions that really became the backbone the Transaction work really became the backbone for our valuation work just simply because we saw that most valuations Being done for businesses really weren't capturing what was happening in the transaction. So we really built out our valuation platform
to really be able to look at 26 different elements that we see actually in real transactions. So your contract lengths and your customer turn and employee turn and net revenue expansion, all these factors, how they actually, they impact the transaction value.
I'm to argue pretty strongly that understanding the value of your business is probably the most important thing you can do as a business owner because it really directs all your ⁓ investment into the business. And most of us as owners and I'm an owner my own business. so I fall into the same category. I'm not exempt from any of the things about business. Like I actually have to not only run the business and be the operator and owner of it, but also really need to look at my business as an investment and how would an investor treat this business. Right. And so I do need to look at what's the return on my investment.
does the return of the dollars I keep putting back into ⁓ IT valuation and is it really the best investment that I have? And so there's a lot that goes into that when you think about ⁓ not only how do I drive the value of the business toward an exit but it's not only just about an exit, about how do I make sure that I have something that's really sustainable and ⁓ profitable. A healthy business is what really provides for me as an
owner but also provides for my whole employee base and my customer base and so I don't think there's anything wrong with being proud of having a highly profitable business. In the end what that gives me
everybody on my team and the same thing for you guys as business owners is you know capacity to be able to handle the downturns that are going to happen in the market. We like to think everything's up but hey if I'm operating at 5 % EBITDA versus 20 % EBITDA, boy it doesn't take much of a downturn if I got 5 % EBITDA before I got to start cutting people, cutting staff, making changes because I can't handle the downturn. When I got 20 % EBITDA, I can take up to a 20 % hit before I actually have to change what I'm doing and not that I'm saying you don't want to make adjustments before
for
that point. My point is a profitable organization gives you a lot more options and it gives you a lot more flexibility. It allows you to carry through on your commitments to team members and individuals. And then also for what you're trying to do from a long-term exit plan, but also just from an investment. you want to attract an investor, if you were going to invest your money, you want to invest in a highly performing, highly profitable organization.
to give me the best confidence as an investor that this investment vehicle is a good vehicle. we really feel that from understanding your value is what's going to lead you to making all the right decisions about producing a high value, highly, market resilient business.
Andrew Moore (06:53)
Right.
So, so let me, let me hop in. want to, I'm to dive into a couple of things there because I'd like the, the, picture that you painted. I, I have some clients. Um, there are some of them are between three and $5 million. Uh, they're running anywhere between, you know, five and 15 % EBITDA. Why should they care about what the value of their business is today? If they're not looking to exit in the next five years, right?
Should you have evaluation done of your business like every five years or just three years before exit? Like what are you, what do you tell people about why they should care about valuations of their organizations and what that means?
Reed Warren (07:30)
You know, I mean, I think so we do have a lot of people
that like, hey, I'll do this when I get closer to an exit. The reality is, in many ways, I'm going to put it back into the real estate thing. You got a house, you bought a house and it's like, well, I want to improve the value of the house. What should I be doing? Right? Well, should I add a deck? Should I add another bathroom? Am I going to return on the investment?
Andrew Moore (07:39)
Ahem.
Reed Warren (07:51)
so on our valuation of service, and I'm not here to pitch it, but so much to say, we do it on a quarterly basis. So we'd have companies that would come back, they'd go, hey, I'm thinking about selling. And so we'd start with the valuation and they'd go, oh my gosh, what you're telling me, Reed, is if I change these half a dozen things, I could add half a million dollars to value to my business. And the answer is yes, yes you can. And they'd go away for a year and then they'd come back a year later and say, okay, let's do the valuation again, I think we got this stuff fixed, and then I'd identify some more stuff.
And so what we got into the rhythm with most of our customers is like, hey, it's a quarterly review. So every quarter we're doing evaluation for you. We're identifying where you add on these 20 different, 26 different risk factors. But then also really looking at, there's really two elements that drive evaluation, right? How do I change the multiple, which comes to those company specific risk factors. And then how do I change my EBITDA? Cause that's what's getting multiplied, right? And so in the end, we're running to look at both of those different elements and say, hey, how do we optimize your
profitability of the business and how do we optimize the multiple of the business and candidly for most people ⁓ it's it's easily a three-year journey to get all those dials all those things kind of dialed in and optimized and so when we think about somebody that is contemplating an exit in the next three to five years ⁓ it when we start that journey there's the proof is in the pudding the puddings your financials and so you can talk a lot
about all the things you want to do and how great your company is. But if I can't see that in your financials, no buyer's going to believe you and no investor's going to believe you. And so when you look at making the changes over time, it really is working through those different elements such that.
Andrew Moore (09:14)
Right.
Reed Warren (09:28)
I can see it actually in your financials where you made those strategic decisions as a business. And now that becomes proof that you've actually made the change and the change is actually working effectively. And so from that perspective, we really like to be able to do it quarterly just because it produces data sets that are relevant and you can, you most people are on a EOS type system. And so it fits into the quarterly rocks. Hey, this quarter, we're going to really work on our contracts. This quarter, we're going to really fix our chart of accounts. This quarter, we're going to do these different pieces and each of those
fundamentally increase the value of the business while you improve on the profitability and on the growth of the business. It also gives me the ability to
when you think about it from a transaction, even from a buy-side perspective. So when you map out your trajectory, you're leaving about 50 % of your growth on the table if you don't have an acquisitive strategy. Now, most people aren't actually set up to go do acquisitions and acquire companies. But I'm just telling you, when you look at your max growth rate, you have a huge opportunity to be able to go do acquisitions. And again, the only way you can really do acquisitions is you have to have a good understanding of value of your business, because you're going to need banks.
you're gonna do debt financing or an investor, if you're gonna give them equity to help you do that. And then fundamentally, the seller is gonna resemble the buyer in the next 12 to 18 months. And so you need to become a model company for what that seller is gonna eventually look like. And so if you're struggling at 5 % EBITDA, growing at 5%, you could buy a completely high performing 20 % growth, 20 % profit MSP, and guess what's gonna happen? It's gonna look like you in as much as you may want.
Andrew Moore (10:37)
Right.
Reed Warren (11:06)
want
to capture the good things that they're doing, you as the buyer are going to dictate the structure in the form and eventually the performance of that company. And so the best thing for you to do is to become a top performing company so that you can do acquisitions of suboptimal firms. And guess what? You're the one who gets the benefit lift from actually transforming them from that suboptimal into that optimal firm that you've become as a part of that journey. And so for all of those reasons, you know, it just make, and we talked about just market resiliency.
in that sense of just there are upturns and there are downturns in the market and the high profitable companies are the ones that can best sustain the downturns in the market and the market's never going to go always up and so from that perspective again a lot of that is just really understanding the different efficiency ratios, the different profitability, know, just start with some of fundamentals of accurate gross margin numbers and I know you do a lot of work with that Andrew on the coaching side of it. If I don't know how making my money
Andrew Moore (12:02)
Yeah.
Reed Warren (12:06)
I got a really problem on sustaining a profitable business, right?
Andrew Moore (12:11)
Yeah, no, for sure. And there's a couple of things I wanted to drill into ⁓ just to kind of get the listeners up to speed on some of the terminology, because not everyone who listens may be completely familiar with some of this stuff. let's talk about, and I'm going to go off script just a tiny bit here, but I think glossary of terms is important because we're talking about ⁓ finance stuff for a lot of folks who are operators. When you talk about multiples,
Reed Warren (12:21)
Sure.
Andrew Moore (12:35)
Can you talk a little bit about what that means? Because you're talking about multiple of EBITDA, you're talking about one times trailing on revenue. when you're talking about when you go in to see what your company's worth and you're a $5 million MSP at 20%, that means you're dragging a million dollars in EBITDA, which is pretty good, at 20%. And then you get a multiple of a
Reed Warren (12:54)
Right.
Andrew Moore (12:59)
So what does multiple mean? Like how do you look at that when you say, my company's worth 5 million, but I expect to get 10. Like what does that even look like?
Reed Warren (13:08)
I would say for the most part, MSPs trade on multiples of EBITDA.
When a company sells, it sells for X number, right? And let's just say that $5 million firm sells for...
seven and a half million dollars, right? So five million revenue sells for seven and a half million. Well, what is that? Well, people take the revenue, the transaction value divided by the revenue and say, well, they sold for one and a half times revenue, right? Or if they had a million dollars in EBITDA, well, they sold for 7.5 times EBITDA. It's a way for us to do comparative analysis to other transactions because most people don't want to come out and say, yeah, I sold my $5 million business for seven and a half million dollars. They would rather say, hey, you know, I sold
for seven and half times EBITDA.
because it sort of veils the transaction and it veils how much I actually sort of made on the sale of my business. And so when you get into conversations with owners, they will never tell you what the transaction dollars really were, but they will tell you what the multiple was. And that's on the multiple of the trailing 12 months revenue, the multiple on the trailing 12 months of EBITDA. The reason why I say it's a little bit of a misnomer is valuations actually aren't done that way. So we're not taking your EBITDA and going, well, you know, that's a 5X. And so we're just going to slap
that on there and that's the value of your business. Valuations are really done from a company specific risk profile. So you can have two $5 million firms and they have radically different values. So if they're a top quartile firm, that $5 million ⁓ MSP could easily be worth $7.5-8 million. And you could as a top quartile firm, if they're producing $1 million to $1.2 million EBITDA, that means there's a lot of stuff they're doing right. They're gross margins, they've got growth rates, so forth.
But you can have a similar MSP that's 5 million in revenue that could easily be worth $1.5 to $2 million because they're just doing everything wrong. And so the difference in those values is not the multiple on EBITDA. The difference in those values has everything to do with the company-specific risk. And so what we try to do in the valuation is we define those company-specific risk factors and then the impact of that to come up with a value. And then we're going to do a similar thing to that.
talked about before, we're going to take that valuation and we're going to divide it now by the revenues and the profitability of the firm to say, hey, this is a comparative multiple back into the business. And so that's where it does get a little bit confusing. But I would typically say when you ⁓
When you look at an MSP as a general rule, they're going to say it trades on multiples of EBITDA. There are some thresholds that you do run into on the revenue side. it's regardless of how profitable you are, it's almost impossible to sell an MSP for more than two times revenue. You have to be really big before that really starts to happen. Conversely, almost regardless of EBITDA, I could have a $5 million firm that's producing no profitability.
Andrew Moore (16:00)
Right.
Reed Warren (16:06)
trade for, you know, .3 to .4 times revenue as a minimum. So there's a couple of boundaries there, because there will be people that'll say, well, yeah, that's five million in revenue, but, and I know you're not profitable, but, I can buy you for two million bucks, because I know what I can do with your $5 million of revenue.
Andrew Moore (16:23)
Right. when MSPs want to start getting ready to value their business. And we talked about this quartile of, of these top quartile firms, what really gets reviewed in order to determine what is part of that quartile, right? Like you had mentioned EBITDA.
But I know we have a lot of other things like revenue mix. And you talked about risk profiles, like potentially like maybe having one or two giant accounts with that are holding 60 % of your total monthly recurring. Can you talk a little bit about understanding what gets reviewed as part of that decision to kind of put these companies in different quartiles and how you start to grade against that baseline of multiples that you had just talked about?
Reed Warren (16:55)
truth.
Yeah, yeah, really good, really good question. Probably the biggest
one that people don't really think about and realize, and that is just pure revenue growth, right? Top line growth. ⁓ And so when you look at it, your growth is your number one, it's the number one lever you have to change the multiple that's applied to your business.
None of these things are standalone. They obviously impact others. But if I have a great sales organization and I suck at delivery, but I can keep growing, I can put 20 % top line growth onto the business, regardless of my churn, which may be horrendous.
I still have 20 % growth and I still have a very viable business that people will pay a premium for because you've been able to sustain growth. And so it's easier to take a growing MSP and make it profitable than it is to take a profitable MSP and make it grow. You can take a growing MSP that has terrible delivery and you can go, well, I can keep that growth growing and fix the delivery issues and I'll even have a better growing firm, right? So your number one driver of value is actually your growth rate.
Your second driver of value, we talk about this a lot with the rule of 40, and we'd like to put those together, is your revenue growth as a percentage year over year. So whatever year, if I grew 20 % last year, great.
And then what's my EBITDA as a percentage revenue and EBITDA is earnings before interest tax depreciation amortization. Long thing there for most MSPs, that's the same thing as your net operating income. So your NOI. So if I take your NOI as a percentage, I'm operating at 15 % EBITDA or 15 % NOI and I'm growing at 20%. I add that together and I have a factor of 35 on a scale of 40. And so 40 is a theoretical limit. We've tested this. You can Google it. There's a lot out there on it.
Andrew Moore (18:37)
Right.
Reed Warren (18:56)
we've seen it hold up true that says an operationally efficient organization. So when you talk about an operational efficiency level, it is on this factor of 40. And so it says, hey, I can grow it up to 40 % as a completely efficient organization. I can sustain 40 % growth indefinitely. However, I'm probably not going to be really profitable. And we have clients that actually do that. They grow pretty consistently, 36, 40%, and they struggle to make 5 % EBITDA. Conversely, you could have people that are 40 % EBITDA.
And no surprise, we have clients that do that. It's no surprise, they don't have any growth. And so as a result, those are kind of, and you can't lean it out and you can't get any more efficient than that. And so what we like to see is see this balance that's gonna be as an investor and as a buyer.
As long as you're between 35 and 40, it tells me you have a really efficient organization. So I care less about the growth rate and the profitability, but I care a lot about the blend of those two. So I can one year you might take 30 % growth and 10 % profit. I'm like, sweet, that's a great, that's a very efficient, they're taking market. And then you might have the next year where you're 20 and 20. And then it's like, well, that's cool. You kind of stabilize and balance. And the next year you can be 10 % growth and 30 % profit. Well, now I know you're harvesting based upon the growth. So it just tells
me as a buyer or as an investor that you're running an efficient organization, you're making strategic decisions about whether to harvest or to capture market or to harvest profitability. ⁓ And each of those things really tells me that you have control on the business. So that rule of 40 is really kind of that second factor. It's obviously very blended with the top line growth. And then similarly, the third one, which goes right along with it is your reoccurring revenue. And it's not because reoccurring revenue is intrinsically valuable. It's that consistent profitability.
is
very valuable. And so reoccurring revenue tells me, hey, you have these contracts that are effectively guarantee me a certain level of profitability on the business. And so we really do like to see your reoccurring revenue pushing in that 65 to 70 % of your total revenue is reoccurring. Now that doesn't mean it's all managed services. It just means between your managed services and your reoccurring product sales, you're getting into that 65 to 70%.
percent total monthly recurring revenue,
Andrew Moore (21:15)
when you talk about that 65, 70 % against non-recurring, you also that non-recurring number is project work or it's hardware? Like where does SAS fit into that? Like, where do you guys look at that? You know, your, your, your PAX8 bill, your Microsoft bill, where does that, where does that go?
Reed Warren (21:32)
Yeah, a couple of questions. If I had a 95 % reoccurring business, would my multiple possibly be better? And the answer is the multiple yes would be better because there's less risk in the organization. However, you would have less EBITDA.
And so the reason why we say 65 to 70 % on the blend is we know it kind of as statistically from looking at top quartile companies.
client is spending $100,000 in reoccurring services and reoccurring consumption with you, we know for a fact that they're going to spend somewhere between $30,000 and $40,000 a year on projects, and they're going to spend probably $20,000 to $30,000 a year on average on product. What does that translate to? Well, that translates to right around 70 % reoccurring revenue, 20 % in projects, and 10 % in products. And so when you come to market, and let's just say you dialed it all in,
and
you got to a 95 % recurring revenue level, most buyers would look at it and say, hey, you're leaving money on the table here in your customer base. You're missing opportunities on projects and you're missing opportunities on products. And so I just tell you from that perspective, if you're getting up into the place where your recurring revenues are on that 65, 70%, don't try to push your recurring revenues higher. Actually focus on making sure that you're capturing all the opportunity in products and projects because fundamentally that'll drive more EBITDA than your
revenue services probably are and as a result you're going to have a you have a higher base now to multiply.
Andrew Moore (23:01)
Right.
And what I found very fascinating about some of the ⁓ work that I've seen your team do when they're doing these quarterly reports. by the way, I ask all my guests not to plug what they do here, but Reed's got this fantastic valuation as a service platform that you can go in and plug your data into. And his team will work with you and you can look at it in a dashboard and make adjustments and forecast and stuff. so you can really dig into gut feeling. So we've had clients that I've done the operations coaching side with
doing the financial coaching on it. And we've looked at it and they were like, we think we're top heavy. And we were looked at and we looked at the numbers were like, you see this, this particular graph right here, this actually, like that validates your your suspicions. So ⁓ I think it's it's really interesting when you start looking at the different data points that you can put together, and how you measure those against this bucket of companies that you've got all of this data on,
How important is it when you're starting to look at gross margin in an MSP because you've got services, you've got tools, you've got a lot of different factors. Where do people want to see some of those numbers? How does gross margin play into this roll up number into EBITDA? And how important is it to this this quartile factor that you talk about from a maturity standpoint?
Reed Warren (24:10)
Right.
Yeah.
Yeah, really, really good question. when you when you think about it, most people's ⁓ operating expenses are pretty fixed. You my rents, my rent, my electric bills, my electric bill, my.
Andrew Moore (24:32)
.
Reed Warren (24:34)
Internet's my internet right there. I can squeeze some of that stuff out But I believe for the most part those are just sort of fixed expenses. the place you have the biggest control on is actually Your cost of goods sold and so you should be having all of your labor
direct labor in cost of goods sold and you really should have broken out by each revenue stream. So I really actually want to know how much of your direct labor is doing time and materials? How much of your labor is actually doing projects? How much of your labor is actually doing managed services ⁓ and breaking those out accordingly? Because in the end that tells me where do we need to fix things, right? So when I look at your managed services gross revenue, ⁓ I'm looking at not only how much are you charging the customer, I'm looking at
Also, how much is it costing you from a product and tool set and how much is it costing you on the labor side to be able to deliver those services? And so from there, we're going to take that in and say, hey, as we look at all these companies that are now in our database, we do know for a fact that top quartile firms are able to get 50 to 55 % gross margins on their managed services. Well, we're going to take a look at your situation if you're at 45, and this is Andrew.
where you come in on it so much it's like okay so we're at 45 how do we change that maybe you just need to simply go get five percent more in a rate increase and that's the easiest way to fix that problem otherwise it may be we're actually overpaying our staff and we should look at right sizing our staff or our tool sets too expensive so until you actually have really articulate cost of goods sold lines where you can see from that revenue stream what is my
cost
on products, what is my cost on labor,
if it's all lumped together I don't have the dials to know where it is that I'm making money and where it is I'm looking losing money and so part of the reason for breaking out the labor into each of those different categories is too often what happens as people just put it all into one and say well they mostly do managed services and then do some project they do some other stuff. Well when you do it that way I can't tell if you're actually pricing your projects right and I can't actually tell if you're pricing your time and materials right and so by
Andrew Moore (26:36)
Right.
Reed Warren (26:40)
By breaking those pieces out, I can actually see where it is that you're losing money or not making money or where you make, you know, candidly
If your price too high, you're also putting your customers at risk because they're going , man I'm not getting a lot of return on that value. So really going through and understanding your gross margins for each of your revenue streams is really good. So at a high level, I like to see 50 to 55 % gross margin on your managed services. If I'm looking at kind of that, you know, I'm going to call it SaaS category, which could be Microsoft 365 or some of those other tools that I'm selling. The reality is nobody's leaving you to get M365 somewhere else cheaper. I mean, you just can't, right?
But I would expect on those, I would say on that kind of Office 365 kind of category, we're seeing typically in that 18, 19 % gross margin. On the broader SaaS, which you could include some hosting and some other tool sets you're providing, we typically see closer to 29%, between 28, 29, 30 % gross margins on kind of that SaaS category. Hardware, pretty tough to get much higher than about 25%, but if you're not getting 20%,
Andrew Moore (27:46)
Right.
Reed Warren (27:48)
you need to look at raising your rates on that. People aren't buying products from you to compete with Amazon. They're buying it because you can actually go implement it and go execute on this, right? So you may just need to raise your rates on your, or just change your markup on your product side of things.
Andrew Moore (28:04)
So let me me drill into that for a second. And this is where I might sound dumb. just try to make me try to make me not sound dumb. But I always in the in my primitive finance mind, I would always tell my team at 20 % on hardware. Because of SG &A, we were basically paying the client.
Reed Warren (28:10)
No.
Andrew Moore (28:24)
to buy hardware for them, right? Because if you're not pulling down 20 % gross on that, once you factor in SG &A, if you're at 22%, you're at a negative 2 % on those dollars, right? Does that does that sound right to you?
Reed Warren (28:33)
Right. Right.
Yeah. I would say that seems a little high to me, but it's not. It's a I'd rather have you make more money than less money. ⁓
Andrew Moore (28:43)
Right.
Reed Warren (28:44)
You from from that perspective, but I would truly say I mean a lot of people are like well I just take their product and this thousand dollar laptop. I mark it up 20 % and I sell it for 1200 bucks Yeah, that's not gonna work because by the time you figure your your cost on the debt like if you're using Financing to buy it when you look at your cost of your time Associated with helping your customer choose that you know when you look at all of those factors Yeah, if you're not getting 20 % you're probably really not I would argue that it's probably closer to 15 % So if you're selling at a 20 % mark
It's costing you 15 % to actually go acquire it, procure it, deliver it, ship it, all those other aspects. 5 % markup, you should quit doing it, right? And so you really need to be in that 22. We do see some people that can get up towards closer to 29 % markup on their hardware and they've just, candidly, they've just gotten aggressive with it and they just say, this is what it is.
But I would say a lot of our clients are actually just simply saying, it's our product. We're not supporting your product. And so just from an efficiency perspective, most of our clients are defining for the end customer. Here's the three laptops you can buy. Here's the server you can buy or two servers. You can choose any one of those. don't care which one. We'll support it. But if it's not one of those, we're not supporting it.
Andrew Moore (29:36)
Right.
think a lot of people feel like in order to get that margin on product, you have to go and charge your client more. And I always remind them that there's another lever you can pull, which is to get the product from a less expensive source. And that could come back to you could go back to your
vendor and if you open a line of credit, maybe they're going to give you an extra 2 % or 3 % on purchases. If you buy in bulk and deal, reg something so you can keep some inventory for standard assets, you could do that. You could even go as far as using HaaS as an option, maybe not for FRU type like field replaceable assets like laptops, but you could certainly do it for firewalls and switch infrastructure and things like that. So there are other ways of being able to move that needle without just
gouging your client, right, and still saying market competitive when it comes to pricing, right?
Reed Warren (30:50)
Yeah, but at the same time,
yeah, I totally, totally agree with you. And at the same time, I would say
you as an MSP, you struggle with the rate increase more than your clients do. And the biggest barrier to actually getting a rate increase isn't your clients, it's actually you being confident enough to say, no, this is a fair value exchange, I should be getting this amount of money Doesn't matter who you are, every end customer will always be happy to get it cheaper. ⁓ they're never going to come to you and say,
you what, you should be really charging me 10 % more for these services. They'll never come to you and say that. The reality is almost all of them will take a 10 % increase and they'll never leave you because of the value that you're providing. And so the barrier is more in you as the MSP owner than it really is in the customer. ⁓ And I would just say we've seen particularly through 24 where we had such high inflation, we had clients that were going and sometimes getting 5 % rate increases twice a year just to keep up with inflationary.
fact they didn't actually have any customer turn or the customer turn was so incredibly low they still were money ahead by going after and asking for the rate increases and so
you just need to be good about getting rate increases. So when we talk about those drivers of value, one of the, it's like fourth, fifth on the list is net revenue expansion. So you should be getting, when you take a look at your existing customer base, ⁓ you should be getting somewhere between eight and 10 % growth out of your existing customer base. Now, 5 % of that growth is going to be just getting 5 % rate increases. And three to 5 % of that growth on top of that should be cross-selling, upselling, and selling them new services or
upgrading them to a new service, right? So ideally, you should be getting automatically without selling a single new logo, pretty close to 10 % organic growth just in your existing customer base. You know, from there, ideally you'd love to be getting, you know,
5 to 10 % top line growth. If you're investing 5 to 7 % in sales and marketing, I think the sweet spot is closer to 10 to 12, personally. But you really want to track that return on investment because that translates into new organic ⁓ or new logos being put on your board through organic growth.
Andrew Moore (33:02)
Yeah, and I've talked to my clients quite a bit about, in my opinion, ⁓ once you get to a certain size, and I usually like to do this four, $5 million, do it at three, but four, $5 million, one of the very first things I talk about is trying to find account management as a dedicated person.
Reed Warren (33:12)
Yeah.
Andrew Moore (33:23)
to be built into a department because at that point you've got the owner and the operations manager and just people who are generally like running around doing six different jobs. If you have somebody that can protect your revenue, right? Focus on reduction of churn, making sure that you're staying sticky, selling those projects, talk about cross sell upsell that that frees up the owner.
Reed Warren (33:29)
Yep.
Andrew Moore (33:46)
to work on additional new logo sales and continue to stay laddered within the account, right? Be their executive sponsor. You don't want them to completely step out. But the way that I see it is when you look at how I've seen the more successful MSPs grow, they begin to develop those relationships at an account management level, which opens up the service manager to be the service manager, the owner to be the sales lead.
Reed Warren (33:46)
Yes.
Right.
Andrew Moore (34:10)
some real opportunity for the organization to grow their existing base as well as pick up new logo opportunities.
Reed Warren (34:16)
Well,
and I'll just tell you, I'll say this about myself because it's true for me. Arlen Sorensen was where I heard it from and I just laughed because it was so true of me too. Arlen said, ⁓ best thing I ever did was quit selling ⁓ because Arlen was always the one that gave discounts, you know, and the reality was probably one of the best things that happened for IT evaluations is Reed quit selling. Not that I'm not a part of the sales process, but
Andrew Moore (34:31)
Good.
Reed Warren (34:37)
everybody because they knew is like, Reed, can you just like, me a discount on this? I'm like, yeah, sure. No problem. You know, and that sales team is going, you know, kind of WTF, man. Why you, why'd you give them a discount? Right. And where my team actually would have the boldness and confidence to go and say, no, this is, this is fair market value for what we're doing. We're going to provide this set of services. This is a fair return. This is fair exchange. Right. And so I just share that. I share that with you guys that so many times us as owners always feel like, Hey, we've actually got it because they know me, we should give them some sort of discount. And I would just say most of your sales team.
or your account managers, no, they're incentivized not to give discounts, right? And as a result, they give a whole lot less. But in the end, let your sales team be the sales team. Let them negotiate the price. They're gonna negotiate it better than you in that sense. But the customer will still feel like, I've got a good relationship.
Andrew Moore (35:11)
Right. Right.
Reed Warren (35:26)
⁓ You know, as we go through kind of an owner-led sales, that doesn't mean that the owner is actually establishing the pricing. I actually find that it's best that the owner not do that and really trust the account management team and the sales team to actually do that portion of the sales journey.
Andrew Moore (35:35)
Right.
Yeah,
when we would sell it, we would let the salesperson, we as executives myself or, ⁓ you know, one of the other owners of the MSPs I've worked for, we would always be there and support the salesperson through that journey and help make sure that we've established a relationship introducing the account manager as soon as we possibly could. And then we would step back and let the salesperson do what they were paid to do. And there's a couple of reasons for that.
To your point, we are just excited to make a sale as anyone. And since we're where the buck stops, we're a lot more inclined to be like, okay, cool. Like, let's just get this across the finish line. You let the salesperson do it. And the salesperson has somebody that they can have like the boogeyman in the background that said, well, I got to go take that to the owner. And then they'd come back and then we'd have a conversation about it. so then we would allow them to try to drive that forward and say, well, let's, let's not give without getting like, we can take that out, but you know, to lower the price.
Reed Warren (36:21)
Right.
Andrew Moore (36:32)
And that was always super helpful for the sales team. And we wound up having a much happier client because they were, the sales team was able to explain the value of what we did versus us just going in and creating a discount to get the contract. Right. So, yeah, I always felt that was really, really an important part of what we're doing. One of the things I do want to talk about. So we've talked a lot about the numbers.
Reed Warren (36:44)
Right, totally agree, yeah.
Andrew Moore (36:53)
And let's talk about the stuff that I want to that as we go through the valuation process, and it may not, this may come into kind of more of on the due diligence side, I guess, as you pass that as you pass into transaction, but as a person getting ready to put together a world class business to drive the value, whether they're exiting or not, what specific things do they need to be preparing in the background outside of the books?
Right. So we've talked a little bit about how you want to break up your books and about how you want to see things in, in, in the accounting. Talk to me about things like contracts. Talk to me if things like they have old partnerships and people who have invested in their business, they've got operational documentation, ⁓ insurance, like what do people need to be doing in order to help manage these risks in order to really understand the value of their organization? What do you recommend?
Reed Warren (37:33)
Yep.
Yeah,
yeah, really good.
Really good question because there's a lot outside the financials that that happens. ⁓ So I would say first of all, of the things that ⁓ when we look at a ⁓ so when we launch a sell side project, we do an &A readiness assessment is really what we do. And yes, the financial pieces is a very, very critical one to it. It's probably sort of the cornerstone for a lot of it. But when you look at those other risk factors that we're trying to capture, probably the second one that's going to come in really close behind is I'm going to call it legal.
And legal is a really broad category, right? So this is going through and actually really going through all your customer agreements and what's assignable, what's not assignable, what are the liabilities. Every buyer's. Yeah.
Andrew Moore (38:32)
Can you double click on that real quick? It talks about
what assignability is because it's something that I've heard come up a lot over the last couple of years and I want to make sure everybody's clear about assignability on contracts.
Reed Warren (38:37)
Sure.
Yeah,
so there's actually two factors, consents and assignments, two different things. so consent is this, you can't sell the business or have material change of ownership without a customer's consent. And so that now means the customer has to be drug into the conversation before you can actually sell the business.
And so, consents is a really huge issue that's there. Most customers want that because they don't want you to sell the business and they don't want the disruption. And so, they want to know about it before you can actually pull it off. And so, one of the things when you draft your agreements, make sure that you draft it so that there's not consents. That's probably the biggest things. Now, a lot of your larger customers are going to try to push you to do that. And you just, you need to take a firm stand and just say, we're not doing that.
I want the ability to be able to operate the business and we're going to run the business without your consent.
don't see as much consent issues today because most customers, except for there's some categories, like if you're doing a lot of work within the government or within municipalities, they sort of require that. You're just going to have to tackle that as you go through it. But I would say it's becoming less and less of a factor. Probably the other one is called assignments. You can't assign this contract to somebody else ⁓ without getting ⁓ approval from the customer. where that's happened, what's happening there is I can't outsource it or
if I sell my business I can't assign this contract to the buyer. And so one of things that you really want to go through assignment ⁓
Verbiage is really common within most people's MSAs and so one of the things you want to take a look at as you get Ready to sell and this is where I when we talk about taking two to three years to get ready to sell This is some of the stuff why it takes two to three years because you'll review your contracts and it won't be your standard contracts It's gonna be all your contracts because you I mean seriously every time we sell a business They're like our contracts are fine And then we go through it and we find out that they've got 20 contracts and that's what there's some of their biggest clients who have assignment clauses and consensus clauses and you
like
well you now can't sell the business without notifying them or you have to go change the contract with them and so it takes time to change contracts so we typically like to do especially if you're going to be selling in a couple years you'll do a full contract review on your vendor where on your customer contracts and you can say hey we're just cleaning up all the stuff we're going to force all of our customers to sign new contracts with us because it's an annual recurring piece and so ⁓
You know, as a result, we can now upgrade all of those contracts in a timely fashion without creating some sort of unusual event that people start going, I wonder if they're selling, right? And so that's.
Andrew Moore (41:29)
Right.
Reed Warren (41:31)
A piece to it. The other one is your ⁓ I would say your operational contracts. So this is your owner's agreement, especially having minority shareholders. That's another place that we see a lot of baggage. It's like, well, I had a partner and 25 years ago, I bought him out. But do have any paperwork to show that you actually bought him out? It's like, well, no, I paid him. You know, here's a receipt for $60,000 or whatever it is. I paid him. Well, technically, if it's not there, he's still part owner in this piece. And we see a lot of
Andrew Moore (41:59)
Yeah.
Reed Warren (42:01)
of baggage like that where, I lost the contract or I lost the agreement or I didn't have it. And so just going through a complete kind of ⁓ operational legal review, just looking at your own operating agreement, making sure everything's clean there. ⁓ even so not trying to get anybody divorced here, but there's oftentimes where the operating agreement doesn't deal with spouses. And so if you have, if you had a divorce, ⁓
you know, there are still maybe rights where the divorce individual still has rights to their equity portion if they're a common law state. We run into that here in Minnesota. There just a lot of pieces there that can really easy to get screwed up. ⁓ And then as a result, they're now a part of the transaction. You're giving away piece of the business as a result. So good operating agreements. And then vendor agreements is also the one that this is a little bit harder because you have to... ⁓
Andrew Moore (42:37)
you
Reed Warren (42:57)
you know, sign kind of what a lot of these big vendors are going to force you to sign, but just really knowing where they're all at, making sure that you have them all there. It's an element of scrutiny, ⁓ that's been agreements and then you're going to get into some of the operating. So this would be leases and loans and things like that. And there's, ⁓ usually a lot of baggage buried in there. we had example, we had somebody who bought the building they were in, but it used to be a gas station. so now you had EPA issues, because you know, there was gasoline on the site and so there.
Andrew Moore (43:25)
guys.
Reed Warren (43:27)
just a lot of stuff like that you just never would think would happen that is buried there and it's all going to come up as a part of due diligence and so really going through a comprehensive legal review in advance of that so that you have time to fix that before going to going to market.
Andrew Moore (43:30)
Yeah.
Yeah, and then things like to any employee agreement contracts, anything that could raise some sort of risk for the organization. You could have something where somebody worked for you 10 years ago and the documentation wasn't quite where it needed to be.
Reed Warren (43:50)
Yes.
Yes.
Andrew Moore (44:01)
I remember in some of our due diligence that came up. were like, explain to me who this person was and why are they no longer here? We don't have a termination notice from them or something. And we're like, that person hadn't worked here in like 11 years. But they asked the question, right? Like there's a lot of that that I remember happening. It was crazy.
Reed Warren (44:08)
Wait.
Right.
And on that, which is super important, especially if you develop, so a couple things. We do a lot of R &D studies, so research and development studies for tax credits. So anytime you're doing process improvement, automation, leveraging AI, you can get an R &D tax credit.
as part of that. Highly recommend you have that reviewed. It's sort of free money for you. We've already paid the taxes so you can go back up until July of this year. You can go back to 22, 23, and 24 and refile if you've been doing any process improvement. So you're just looking at those internal projects that you're working on. If you switched from ConnectWise to Kaseya or vice versa, or you decided to use ⁓ ITGlue, anything that you spent on that from an internal perspective can be used as R &D.
Where I'm going with that is, hey, that's intellectual property.
So unless you have a statement within your employee contract that the work that the employee's done is ⁓ work for hire and you own the rights to everything they develop, ⁓ you know, that's a good thing. A lot of people don't have that in there. And so now what happens is if I have, if I've built ⁓ any sort of automated process that I can now charge a customer and I go to sell my business and the guy you know, had done a lot of the development from it, he actually could claim that
he has rights to that product or that automation that he's built that now needs to be paid to him as a result of the transaction. So, you know, we've had a lot of those times where even in the employee agreements, the buyers come back and said, hey, before we're actually going to buy this, you need to go through and actually get intellectual property rights assignments from all your employees. And that's, might as well just tell our employees, you're selling the business because that's only reason why you ask that. you just, again, that's one of those things a year to two years in advance, you say, hey, we're going through some corporate high
Andrew Moore (45:47)
Right.
Yeah.
Reed Warren (46:09)
We want to standardize these pieces. ⁓ And I would say with that, see so much, not only the intellectual property rights assignment, but we do see a lot of stuff where it's like, they've been employed for 20 years and never really had a contract.
Yeah, that can be a problem because then you could have an employee claim that I wasn't fairly paid or there was all sorts of issues. so again, ⁓ good corporate hygiene is going to tell you that you need to stay on top of these agreements. need to have every time somebody gets a raise or their job title changes, they really should have a revised employee agreement. ⁓ Employee handbooks should be signed every year so that they're in change. You know, any of those changes are happening. There's just a lot of that stuff that normally you don't think about until you actually go into a transaction.
So that legal side is just when we talk about legal as one of the elements. Yes, it's a really big element and that's just one part of it. ⁓ And then.
Andrew Moore (46:57)
Right.
Reed Warren (47:01)
There's plenty of others that you're to need to look at from an insurance perspective. There's a whole bunch of insurance stuff, particularly around D &O insurance. People oftentimes don't have and is being more more required, obviously cybersecurity. And you're going to have to go through all those policy kind of transitions. Usually that's one of the last things before close. And almost every time there's insurance related stuff. And then the other one that usually bites is, you know, leans against the business.
And so any unfortunate reality is sort of anybody can do it. And so anytime you, you know, borrow money, they can put a lien against the business. It's not a surprise, but what becomes surprising is all the little stuff that you never thought about that suddenly, you know, can be there and it will hold up the transaction. So you might've had a, we see this probably more with Chase. I'm not trying to complain about Chase banks, but ⁓ you might've had a loan with Chase and you closed the loan five years ago.
and however they never took the lien off the business for the loan and even though the loan's been paid and the loan is set at zero and it might even be in the records that the loan is that there's zero money owed the reality is they have a lien against the business you can't sell the business until that lien is cleared and so then if you go work with chase three days before close day you got to get this lien release it's like a two-week process for chase and so it's just one of those things you need to do take a look at do a lien search on the business
before you do it. We've seen crazy stuff there from, somebody bought a lawn tractor and put it on their corporate car, but there was a lien because the car on the business. We've seen my favorite was a guy ran a toll booth and a company car. And so the state actually put a lien against the company vehicle because he hadn't paid the he hadn't paid the fine for running the toll booth. And it was like only like 240 bucks.
But we literally couldn't sell the business because the buyer is going to require that there are no liens against the business. And so we're running around trying to figure out how in the world with the state of Texas, do we pay a eight-year-old toll booth fine for 240 bucks so we can get a lien release, right? So there's all sorts of crazy stuff that happens like that, but that's something else that you do want to take a look at. And you can head off certainly early by going through and doing it.
Andrew Moore (49:08)
Right.
Yeah, and it sounds to me like, it just comes back to this, right? Everything that I've heard you say, everything that I've been talking to ⁓ my guest about over the last few months is, surprise, surprise, if you want to run a business that is profitable, that is valuable, that is not going to have your hair on fire all the time, I we are in the IT services space, right? ⁓
it comes back to being consistent and deliberate. And as you begin to baseline things, let's just say today I woke up and I want to be a more ⁓ stable MSP. And so I'm going to go get all of my client contracts and I'm going to start reconciling them. Well, that doesn't really do you a lot of good if you don't create
a process or amend process to say, and now every time I get a new contract, I'm going to keep a copy in my operational database. And I'm going to keep a copy in my data room, like my folder that I keep all of my information in. so you have to go through the process of being deliberate and focused on it. And whether that's a quarterly review of the finances and an annual review of the, of the data repository that you're keeping and stuff. So I think that it sounds to me like,
We really want to encourage people that this is not a one and done or this isn't, hey, let's start doing this six months before you decide to sell. This is, again, minimum three years. But if you really want to run a business, maybe get one of these valuations done, go through the process of understanding what that looks like, and then create some consistency so that when the time comes, the forklift isn't dramatic, right? And you know what you're going to be getting. It's not going to be a surprise.
Reed Warren (51:03)
Right. Right.
Well, I know what you say. mean, it's sort of when you think about the journey from going to market to let letter of intent to due diligence to legal proceedings and to close, I would equate it to it is very much a marathon. Can you run 26 miles? Well.
I could maybe walk 26 miles and that'd be in a world of hurt, right? And so when you think whether you like it or not, once you start that journey, it's a marathon. And the candidly, the more you condition beforehand, the more you prepare ahead of time, you can run that.
the point I'm trying to make with that is the more you can prepare the better off you're going to be one of things you just touch on I just want to reiterate because it's really foundational is ⁓ most most sellers
don't want their team to know that they're selling their business, right? They want to keep it in the dark. The problem is, if you haven't prepared ahead of time, there's almost no way to keep it a secret because you're going to start asking for a bunch of stuff that everybody's going, why are you asking that? You never asked for that before. Why are you worried about it now? And so what we talk about we talk about that kind of corporate hygiene, we do want to get to the place actually when we start that journey that just says, hey, we want to run this business efficiently. We want to run it correctly. We want to have all these legal reviews. We're going to create a repository.
or effectively a data room and we're gonna keep our financials there, we're gonna keep all our contracts there, we're gonna keep all our engagements there, we're gonna keep all our employee agreements there, we're gonna keep all the stuff you need for due diligence. But now I have my team just used to like, hey, every month the financial team puts up the next set of financials. And every time the sales team closes a new agreement, they update the agreements in this folder. And so now everybody's in the rhythm of keeping all the data that you need for a transaction up in a place it's always current.
You then don't have to ask any unusual questions. You just like, hey, can you guys make sure that section's updated, right, for the different pieces that they contribute towards it? So everything from payroll reports to, like I said, agreements to operating agreements to vendor agreements to financials to sales pipeline, ⁓ even, hey, we have a repository of all our processes that we use for running the business. It should be in a standardized spot. It should be kept current. So you get the whole company accustomed to documenting
accustomed to uploading it to a central location and now quite candidly you have a complete data room that's available for an investor if you need to bring an investor if you need to show a bank because you want to borrow money to be able to do acquisitions or other things with the business it's all ready it's all there it's all available you want to sell the business it's ready it's there it's available and nobody in your team is going boy why did he ask for that
Andrew Moore (53:46)
Right. And I will say this, ⁓ having lived through this process a couple of different times with MSPs, it is an intensive process for the seller ⁓ and as an owner who might be integrated into the business heavily.
you will be required to be extracted from some of the day to day simply because of the amount of effort that you have to put in. It could be nothing one day. It could be six hours. It could be phone calls. could be legal reviews. It could be contract explanation. So I will say that if possible,
One of the things that I would strongly recommend is making sure that you're developing line of succession as an owner. We talked about it early in the episode today where you and I talked about, you know, getting a great account manager, finding a good salesperson, being more of a manager of people and allowing those people to do their jobs at a high level from a maturity standpoint, because when it comes to the sale of your business, you're going to get sidelined from some of the day to day stuff. And even if you can keep up with some of it, the amount of effort you put in after hours is going to be crippling to you to make decisions during the day to
run
your business. So having a good second lieutenant, having good people that work underneath you in order to keep the business running through that process, I feel has been invaluable for the companies I've seen that were able to do that. And the ones that didn't, it became apparent to the other people that the boss was acting weird and stuff was going on and nobody knew. And so it became really unpleasant. It wound up creating
I think some churn within the organization from a personnel standpoint, rumors started floating around and it just got to the point where it went from being a really neat event for everybody to being this unpleasant thing because everybody was slammed and they didn't realize what they were getting into, right?
Reed Warren (55:26)
Well, and truly, when we look at it, you're just exactly right on that. So it's another risk factor. It's owner dependency. How dependent is the business on you as the owner to be able to operate as a going concern? And the more dependent it is on you, the less valuable your business is and the harder it is for you to be able to sell it. And so on that point, bringing up a team from an hours perspective, when you go into the pre-letter of intent all the way through close,
you should expect to be putting probably at least 20 hours a week into the sale of your business. So we encourage people to go get to the place where you've delegated, you've got your team managing it, you're actually running on 20 hours a week. So you can now handle 20 hours a week of due diligence and all the related sales stuff and you're not killing yourself. But I'll tell you this, doesn't matter how many hours a week you're doing, you will put another 20 hours a week easily into the sale of your business. So if you're running 60 hours a week, guess what? You're gonna be nearly killing yourself
to get through all those different pieces on that and you're to be working nights, weekends, whatever it takes to get it done. And candidly, that M &A journey from letter of intent to close, speed is probably the most critical factor.
⁓ because the longer you take, the more questions everybody's gonna ask. And so if you give an investor six months to ask questions, the investor will take six months and ask you questions and then ask for updates on those questions every month that goes by. Where if you can actually go from letter of intent to close and a good buyer will do that in two months.
Well, yes, it's a race, but it's only two months long, not six months long. And so how well you have your data together and how well you delegated down to your team to be able to run the organization without you is a huge, huge element, not only to the success of the transaction, but just for your sanity. And there's the pressures upon you as you go through the journey. So owner dependency, we talk about it. You want to get to the place where you can take a six week vacation from the business and everything runs fine. When you can do that, you're probably in a place
pretty low owner dependency and that's candidly one of the most valuable positions for the business from an owner dependency perspective.
Andrew Moore (57:40)
Well, and I think it's a great place to wrap up the conversation before we get into our questions here is that every owner I hope is looking for a business that is valuable, that is fun, that they get to do the stuff that they enjoy doing. They're not killing themselves. It's running on their own. And so, you know, everything that we've talked about today and then all the things that we've been working on with the channel, you know, in, the MSP community is how do you create an accountable company that functions with structure?
and metrics and clear deliverables and outcomes for the employees and the clients. And if you're able to start implementing some frameworks around that, you'll get to build a company that's valuable. You'll get to take your time as an owner to do the things that are important to you and to be a part of what goes on in the channel or to spend your time in the ways that you want to. And by the way, when it comes time to make an exit from your business, it's not going to be a shock to your system. You know what to expect and have the time to do it. ⁓ Reed
Reed Warren (58:36)
That's good.
Andrew Moore (58:37)
I want to thank you so much for being on the show today and taking the time to talk to us. This has been incredibly helpful for me to understand more about what goes into valuations and how the folks that are listening to us can make better decisions about the value of their company. So I appreciate your time.
Reed Warren (58:54)
Oh, it's great. This is a fun conversation and grateful to be on with you.
Andrew Moore (58:59)
Awesome. All right. So let's ask a few quick questions here. I'm asking five questions. Right. What's the best business book that you've ever read that helped you hands down? What's the best one?
Reed Warren (59:08)
⁓
So actually "Buy Back Your Time" That's been personally probably one of the most ⁓ most effective ones. The second one that's a close one. So that's really more of a personal thing. How do I manage my time? ⁓ And then the one right behind that would be "Managing a Professional Services Firm" firm.
Andrew Moore (59:12)
Okay.
okay. Okay. Well, and for those who are listening, I will look those up and put them in links into the, the show notes. but yeah, that's awesome. Okay. That's really, really good. ⁓ all right. Okay.
Reed Warren (59:27)
Dead.
The third one, think we'll one more on the third one because this one's
probably better for the audience. Simple Numbers by Greg Crabtree.
⁓ You want to so much of actually what we built a lot of those pieces came from him. We didn't get a chance to talk about labor efficiency ratios. Really, really, really good when it comes to around those gross margins that we're talking about is actually am I getting the most out of my direct labor? Am I getting the most out of my management labor? ⁓ Two real important numbers you look at, but he's great book. If you followed his metrics, you'd run an incredibly healthy organization.
Andrew Moore (1:00:09)
I've heard a lot about labor efficiency and looking at those numbers and that's become kind of, I'm not going to say it's the new buzzwords, but I'm hearing it more and more and more as I'm out coaching with our clients, which is people are really focused on utilization and labor efficiency. And that that's a kind of a big deal, especially in a services company. So, um, love that. Okay.
Reed Warren (1:00:29)
Yes.
Andrew Moore (1:00:32)
What if you had to if you had to say a bad word, which in fairness, I don't think I've ever heard Reed say a curse word like he's like it and Jason and I were having
Reed Warren (1:00:38)
Yeah, I did say she's not on
the show, so you may have to edit that out. no, I'm not a guy who swears a lot, but I will drop an F-bomb every once in a while. But it's pretty high on the pressure load before I'm doing that.
Andrew Moore (1:00:43)
Yeah, yeah.
Okay.
Yeah,
that's that's fair. that's so I've I you you know me, I'm a little salty. I try not to offend people with my language, but ⁓ I just I pepper it in in different things. I have another guest who likes to pepper in but I'm finding more and more people who are just like, Listen, especially leaders I've noticed a lot of leaders are just like, I'm not going to use a word unless I absolutely
intend it to be used. I mean, other than getting, hitting yourself with a hammer, right? Like there's a, but like when you're in a mixed group of people, folks are going to keep that kind of at a, at a very high level. So I appreciate that.
Reed Warren (1:01:22)
Go. ⁓
Well, I did hear an interesting
statistic on that though, that if you throw in, if you sprinkle in some curse words in some language, people tend to perceive you as more truthful. So, and I think that's actually, I think there's an element of truth to that, honestly. Whereas like, hey, that just shows kind of a raw authentic individual. And therefore I'm more confident in you than somebody who's always has a smooth, bright answer, never gets ruffled. And so anyways.
Andrew Moore (1:01:41)
Interesting.
Yeah.
Yeah.
No, I like that. No, no, no, you be you. I love that you're you like that. ⁓ It keeps me straight because if I weren't around folks like you and Jason more I would I would sound like a sailor like all the time. So it's super helpful. ⁓ Okay, so band or music artist, which one is your favorite? Like who you go in to see? What is the one that like, not feeling great, but you got to put that album on what who's your favorite band? Who's your favorite?
Reed Warren (1:02:00)
So maybe I need to sprinkle more of that in.
Okay.
like Lindsey Stirling. If there's Lindsey Stirling, she's electric violin and she's got a ton of stuff out there. ⁓ If I'm looking to actually focus, work hard, I need some good adrenaline pumping music, I will listen to Lindsey Stirling.
Andrew Moore (1:02:30)
Okay, who's Lindsey Stirling? do I'm not familiar.
⁓
Okay.
Okay, Lindsey Sterling, will also ⁓ link to something for her so that anybody can check her out. That's awesome. What is the note, and you don't have to use names unless you really want to, what's the worst sales call or meeting or personnel meeting that you've ever had? Like the one where you just are like, it's.
Terrible and it's hilarious and it's awful and you just had this call and you met with a client or you met with somebody and it was just not great
Reed Warren (1:03:14)
Worst one, yes. ⁓ Hopefully I'll try to keep this short. So we're representing the buyer ⁓ on this situation. we ⁓ got to ⁓ the day before close, everything had been negotiated. The buyer came to me and said, hey, ⁓
we need to buy this company and we have to make sure it gets done today, but we need to have them leave their $400,000 of excess capital, their excess cash in the business because we can't make payroll. To which I had to say, you shouldn't buy this company if you can't make payroll. And they're like, no, we actually need you to go tell the seller that we're going to redo our agreement so that they leave the extra $400,000 in the business so that when we buy them today, we can actually make payroll in four days.
And that and so I said well look I will do that for you, but I'm also gonna tell you and I'm gonna tell them the same thing Neither of you guys should do this transaction So I did I went to the seller and I said you're not gonna believe this and they're like believe what and I'm gonna and I said I told him sorry Here's the situation And you should not do this
Now the mistake the seller made is the seller had had the buyer to their office. They had already announced the transaction, even though it hadn't gotten done. And the seller was like, after swearing at me for 20 minutes, ⁓ said, what the fuck? I can't back this thing out. So we're going to go ahead and do that. And so he gave up $400,000 of cash to close the deal so that the buyer could actually make payroll. And surprise of all surprises, the deal fell apart. mean,
six months later they were trying to unwind the whole thing. anyways, that was the probably the worst meeting set of meetings calls I have ever been a part of. And I can't believe that either one of them actually have the audasity to ask for it and actually had the sanity or insanity to actually do that. So.
Andrew Moore (1:05:07)
Wow, that so
and that's a that's so just to like, kind of poke back to like our previous conversations. Something that shocks me is that in the statistic I've heard banded around is like 90%. But I don't know that is that high like a lot of deals that people are really like they're gonna get them done. They fall apart. Right at the last minute like not all when you go down even after LOI like how many deals
Like, I mean, what would you give it? 50 % 70 % 80 % like how many deals just don't make it across the finish line?
Reed Warren (1:05:42)
I would say most of the ones that we do, do, but that's because we kill it pretty quick if it's not going to get done. And this is one of the ones that was late in the game and I would argue pretty strongly and I did tell both of them they should do it. I firmly believe neither party should have done it, but both of them felt too tied into it.
⁓ but I would, I would say it's probably close to 20 to 25 % actually don't get done, ⁓ as a part of that journey. And, and, but I would say there's a lot that get done that shouldn't get done. And a lot of it, similar to this situation, it's been such a long journey. It's been such an emotional journey. You're so snake and tired by the time you get to the end that you're
just
like, you know, kind of WTF, ⁓ just do it. Let's just get it done with how bad is it going to be. And if you're saying that you shouldn't be doing that. ⁓ And so ⁓ I would just say as an advisor, we work really hard and we've gotten harder on this to say, you know what?
Andrew Moore (1:06:28)
⁓
Yeah.
Reed Warren (1:06:45)
you guys shouldn't do this deal. If it's not a win-win, M &A is one of those categories, so it's either win-win or it's a lose-lose. There's not one's a winner, one's a loser. And so if it's not gonna be a win for the seller, then it's not gonna be a win for the buyer, and neither party should do it.
And so we really try to be very careful on our sell-side process that we're making sure we're walking a really good process, but...
we're helping to intervene with seller fatigue and buyer fatigue. And we talk about it, fear, doubt and greed. Those are the four elements that happen in every transaction and just making sure that people are in the end making the right decision and not just making a decision to be done. So, yeah.
Andrew Moore (1:07:24)
Right. Well,
and that that's helpful because I think especially for your business, you don't want to get a reputation as you used to call it a puppy mill, right? You're like, I'm just going to rock transactions. And if they fall apart, they fall apart, right? You'll get you'll get a reputation of, you you're you're like, you're the Scott Boris of, of I have the MSP space, like you're going to get people money, but at what cost, right? Like, what is it? What damage does it do to the market to the reputations of the people involved?
Reed Warren (1:07:40)
Thank
Yeah.
Yeah, yeah, we like to count the transactions one year later when both parties said it was a good deal.
Andrew Moore (1:07:55)
Yeah, I love that. All
right, last question. Who needs to be on the podcast that like a person like who do you think would be really good for me to interview that I haven't talked to yet? You got somebody?
Reed Warren (1:08:04)
Yeah, really,
really good. There's, there's probably I'm gonna start with one. I would put it definitely put a lawyer either a Nate Nelson or
⁓ Beth ⁓ Schroeder, two attorneys that we work with quite a bit, but just actually talking through the legal elements of it. They both do a lot in the Managed Services ⁓ MSP space as transaction attorneys. Nathan's a tax attorney as well, and so can just kind of address those issues. And so I would just say that's one of those things that ⁓ people talk to their attorney last, and in many ways you should talk to your attorney first. It'll save you money.
Andrew Moore (1:08:42)
I love that. Yeah,
no, I will definitely get some contact information and see if I can't get the invite over to them and get something recorded because definitely legal is on my list of topics to cover over the next few weeks and months. So I want to get something put together so people can learn from that too. ⁓ Cool. Well, Reed try to not freeze, I guess. Like, yeah.
Reed Warren (1:09:00)
Awesome.
That's right. It's going to be 20
below here in the next couple days. So yeah, we'll just.
Andrew Moore (1:09:09)
What do you even
what do do? Like when it's 20 below? Like how do you even manage your house? Like, that's insane.
Reed Warren (1:09:16)
The same thing people in Arizona do when it's 120 degrees outside. And you stay inside and make sure the heat runs. ⁓
Andrew Moore (1:09:20)
and stay inside.
Down here in Texas, it's gonna be like 15 and they've declared a state emergency and they're shutting everything down and everybody's encouraged to go get gas and extra food and batteries and so I don't know. We'll see what happens.
Reed Warren (1:09:42)
⁓
Minnesota, there's nothing like that. just, yeah, that's what happens every winter. don't lick any flagpoles. That's all I can say. All right.
Andrew Moore (1:09:48)
Yeah, yeah, they're like, yeah, suck it up, buttercup, like
Great advice, Reed. All right. Well, I appreciate your
time and I thank you for being here. Thanks.
Reed Warren (1:10:00)
All right, awesome. So grateful for it. Thank you.