The pros and cons of MSP private equity deals

Potential drawbacks of private equity in the MSP market

Sobel: Sure. [You] and I have had some conversations on, and I know I'm clearly on record as having some positions on, private equity. And I know we've shared some thinking on the fact that private equity, I've said, changes markets. That's just a statement, right? And then you've been as bold as saying you don't think it's great for MSPs. Tell me a little bit more about your legacy position on private equity.

Melby: Yeah, and the foreshadowing is thick. I can just ruin it by acknowledging that we had an event in August that involves private equity. I've railed against private equity in the MSP space. My view of it has been that when equity groups come in and look at two healthy companies and say, 'Oh, you guys' -- MSPs just check all the boxes for private equity groups. It's recurring revenue. It's technology. It's shiny. It's new. And there's all this dry powder. So, private equity groups look at it and say, 'All right, I'll take these two MSPs. They're healthy. We'll smash them together, and we'll get the strengths of all of it.' Well, it doesn't happen that way, for the most part. I think most MSPs have seen the downfall of when two companies are put together and then the fallout for the employees, for the clients. We salivate every time one of our competitors gets acquired because we just assume -- we know -- we know the employees and the clients are not at the forefront of that deal and that conversation. And the reason is, is that MSPs are people companies and it's a personal industry. And if people don't realize that, especially equity groups, they don't get the result they want, because two plus two doesn't equal five. Two plus two equals three, when you start to see the attrition and all the things that happen when you lose the relationships.

Greystone Technology's private equity deal

Sobel: You've entertained discussions [with private equity players], because you always have the conversation to learn and to grow, and that's the benefit of having those conversations. I'm going to presume a little bit that you had a bunch of those [discussions] and never moved. What changed? What are the circumstances that made this different and changed your opinion or your execution?

Melby: Well, first, I'll start with what didn't change, and that's the fact that my opinion on private equity in the MSP space still holds true. I don't take any of that back. You're exactly right: I think if we count over the past two years, we've had 400 different organizations or different people reach out to us, because that's the nature of this space right now. Again, we're a shiny object, but the reality of it doesn't end up being that shiny. So, the biggest thing that changed for me in this was going through the process, as we did a few times to your point of always being interested in learning what's out there. Enterprise value wasn't a concept that I was considering when we started this, but obviously that's grown over time, in terms of just something that we pay attention to. But, really, it's about what's the best logical step for everybody involved moving forward? And so, I think when [you and I] first caught up about [the Greystone Technology sale], when the announcement came out, I said, 'All right, so you know what I've said about this, so I'm pretty sure your question is did I sell out, did something change, or did I find something unique?' And the reality is it's probably a little of all three in terms of what changed for me.

It started pre-COVID. As we came into 2020 looking at the risk profile of MSPs and the risk tolerance, and recognizing that as bootstrap companies, as organizations that are typically asset light, we hold a pretty incredible amount of risk, especially in the current cybersecurity landscape. So, looking at what that meant moving forward, yes, I could continue to grow my organization and have it be closely held with just me and my partner, and [see] that there's some comfort in that and there's security in that. There's also some massive fear in that, of not having any financial diversity in the organization. So, that was actually the first thing that caused us to look at things a little bit deeper. What would this look like with a healthier foundation? COVID hit, and all of a sudden, that became a little bit more of a focus, especially in the early days, but this wasn't a COVID-specific transaction. It wasn't the kind of thing where we looked at it and said that [selling the company is] what we needed to do because we were afraid of where the market was going.

The other things that really changed for us was getting connected with New Charter Technologies and Oval Partners, who are the private equity group and the investment group, and recognizing that there are some things that are consistent about all private equity groups. The focus is financial, but beyond that, not all private equity is the same. And so, there are a few things about this situation, as we looked at it in terms of both diversifying what my future is and what our future is. I mean, I'm in my 30s. I'm not trying to leave. I consistently want to do something bigger, bolder, and I think for anyone who knows me, I'm not really interested in doing what everybody else is doing. So, there's an opportunity to change the story of where MSPs are going.

Sobel: So, you're not punching out? You're not done?

Melby: I am not done, no. And that was actually a big part of it. Oval invested in two areas. It was started by two partners, Jake [Mizrahi] and John [Knoll]. It's largely their capital that they're deploying, which makes a big difference because there's a personal connection to it, even though they don't profess to know how to run companies in our market. They've chosen two industries. They chose the managed print industry five years ago, and they chose the MSP, the IT service provider industry, a year ago. And their whole model is, 'How do we promote and build company health, not smash things together to say we have one company on paper when beyond the paper it's just a fragmented mess of people who don't like each other?' That was key.

The other key was [that] because they're not looking at consolidation, because they invested for us to continue to build our company and our brand, our values, that align very, very closely with theirs and the other portfolio organizations, they want us around. They want me there. They don't look at this and say, 'Let me buy your company so I can run it better than you. Let us invest so that we can support you in running your company better.'

And so, a lot of that for me was like, 'Wow, I have a chance to learn.' And some of the things I'm going to learn I know I'm not going to like, but we're five months in and it's better than I expected. And I'm not a 'glass half full' guy when it comes to that stuff. I'm the person who's looking for the frayed edges and looking for the cracks.

And the reality is that we're living in the reality together. There are things that are challenging. There are things that are great. I think we'll get through years into this portfolio thing, and there'll be opportunities or situations where we'll look at it and say, 'Yeah, maybe it makes sense to do some consolidation within the portfolio,' but it's because it's the best business thing, and it's the best thing for the clients and the employees, and we've known each other for years, and we've worked together for years. It's far different than, 'Hey, we decided that you guys are going to get married with this other group. You've never met them, but we promise it's going to go fine, for us. We don't really care how it's going to be for you.' That's kind of the private equity view I've had in the past.

How the deal differs from typical private equity MSP acquisitions

Sobel: So, the difference here is it sounds like it's very structurally different. We oftentimes think of, particularly when we think about vendor [acquisitions], [it as] they're buying a piece of technology, they're all slamming it together. I call it the PE [private equity] playbook, where it's like, 'Well, we're going to get rid of the extras, and we'll roll it up and we'll get efficiencies,' right? It sounds like, for you, the difference here is you've come in and you're a part of the group, and I think that's a critical part of the deal. So, you're a part of the group and your company bought you into the portfolio is one way of looking at it. And now you're at the table as part of an organization, all of you trying to build these businesses. So, you're right: Two plus two isn't five. It's three. But three is bigger than two. And so, if everyone can make the pies bigger, over time, then everyone wins. Is that a fair way of thinking about it?

Melby: It is because, for us, it's not adding two plus two equals three. It's how do we get everybody from two to three faster? And so then, all of a sudden, two plus two equals six. We're just not pretending that it's the same thing. So, there's brand equity that lives on and all of that.

The other key thing in that is, yes, I'm at the table. We have Class A stock. So, our reinvestment, which is a huge part of this -- I mean, this wasn't an exit plan. This is really a double-down for the future in a lot of ways. So, we have the same shares of stock as the private equity group, which is very rare.

Sobel: Right, it is very rare.

Melby: Yeah. The final question we had when we were looking at doing this is, where are our customers and employees better off? And that sounds maybe falsely altruistic or searching for a little bit of confirmation bias as we wanted to do this transaction. But I think if I look at where my greatest consternation has come [from], and biggest challenges have come [from], over the past 20 years, it's when my employees aren't brought into the vision and we're struggling with our clients. And so, I looked at it and I said, 'My life is better when my employees are engaged and moving forward and don't need me to do everything with them and [are] really working with autonomy. And when our clients know the value that we're producing.' So, given that I'm going to be a part of this for, I mean, really permanently into the future, is my vision, I've got to make sure that my life's not going to suck, too.

Staying true to the business's core principles

Sobel: I don't think it's cliche. I actually think there's some real value in saying, 'Hey, if clients and employees are served well, it creates value.' That basic math equation of business, there's a reason it's basic. It's not cliche. It's because it works. And the businesses that don't pay attention to that don't unlock as much value. That's always been my thinking on it.

Melby: Yeah, you're exactly right. And I think that that even connects a little bit to where the private equity conflict comes in at times, is the fact that private equity is obviously an investment focus. And, again, it's a little easier when the money is more closely held and it's not just managed through a fund with all kinds of different investors with different priorities who just want to see the numbers. That really helps a lot. As we went through with these other [private equity] groups over the years, it all sounded like, at the end, 'How much can I pay you for you to sit and watch me destroy what you spent 20 years building?' And I'm sure there's a number. But I never found it, for one.

And realizing that in this my team is a huge part of the equation, too, and they're looking at me saying, 'Please don't do what those other people have done.' Some of them have come through transactions that have happened. That was one of the things, as we talked to our team about it to help them understand that, yeah, I'm not going anywhere. My partner's not going anywhere. We have new opportunities because of this. There will be some tradeoffs, but the tradeoff is worth it because the tradeoff comes any time you diversify risk. You have to diversify control and the input and the influence. And so, it's about choosing the right people in regard to all of that.

That's what I'm excited [about] in terms of where we're at, because we ended the year stronger than when we started the year, post-transaction. I think a lot of the transaction gave us confidence that we had the foundation to move forward and not second-guess ourselves, and third-guess ourselves, every step of the way. And that's what we want to carry forward into 2021, as well, given that it's still kind of a crazy, uncertain market out there.

Exit strategy advice for MSPs

Sobel: I would normally ask what's next, but it sounds like you've answered it. So, instead I'm going to make [this] my last question. We both know that a bunch of the people that are going to be watching and listening to this are MSP owners who have dreams of their own exit. And what I'm going to ask is, what's the one thing you really learned through this process, maybe that surprised you, that you want to pass on to those people as they think about their own next step, exit, whatever that event is? What's the advice you'd give to them?

Melby: The number one thing that I would say is prove your reality. And what I mean by that is the fact that MSPs, typically, [are] lifestyle businesses for a lot of people -- and I think for most people. And then you look at it and you say, 'Well, I also want it to have enterprise value.' Well, enterprise value comes from profitability, through and through. So, for years, one of the things we said is, 'Well, we're going to keep investing our profit in ourselves and we're going to grow.' We don't regret that at all. That's exactly what helped us to get to where we're at. But don't sell or take an investment or do anything like that until you have aligned financial goals with who your connecting with, with who you're partnering with. If our goals match our PE goals, and if our vision matches our investor's vision, it's not that scary and we get what we want out of the deal and all of those things.

I think the real challenge comes from situations where you look at it and say, 'Well I'm not profitable, but I could flex myself into an uncomfortable profitability to prove that I can be bought.' It's not going to work because it's going to fall apart. And it might work in that exit plan where you just watch it all fall apart after you dupe someone into paying you some money. Find your profitability. Find your foundation for you, not just to sell. When you've got it and when you're looking at it saying, 'Yep, I've got my secure financial foundation as a standalone organization,' number one, you're going to be far more attractive to someone, but the pressure to sell isn't going to be there. I mean, that was the best part of the whole thing, is that my partner and I looked at each other every other day during due diligence for the investment, and said, 'We don't have to do this.' So, find that discipline, find that healthy structure, but don't do it with just an eye on selling or an eye on taking that event. Find that health for yourselves and then find the right people who know the value of that.

Sobel: Thanks for listening to this bonus episode of The Business of Tech. If you like this kind of content, you can support me directly. I've got a Patreon, and you can give what you want. Visit Patreon.com/mspradio to help out the show and keep this going. If you like this kind of content, 'like' and subscribe here on YouTube, and check out the show every week on YouTube as a full show or daily in five minutes on The Business of Tech podcast, available on all your favorite podcatchers. Find subscribe links at businessof.tech, and I will talk to you next time.

About the author
Dave Sobel is the host of the podcast The Business of Tech, co-host of the podcast Killing IT and authored the book Virtualization: Defined. Sobel is regarded as a leading expert in the delivery of technology services, with broad experience in both technology and business. He owned and operated an IT solution provider and MSP for more than a decade, and has worked for vendors such as Level Platforms, GFI, LOGICnow and SolarWinds, leading community, event, marketing and product strategies, as well as M&A activities. Sobel has received multiple industry recognitions, including CRN Channel Chief, CRN UK A-List, Channel Futures Circle of Excellence winner, Channel Pro's 20/20 Visionaries and MSPmentor 250.