It used to be that the family business was passed on to the next generation. Time, social/cultural differences and economics have changed that reality and today, many privately-owned alarm dealerships are selling the business rather than keeping it in the family.
To get a read on the situation, we talked to three industry experts who provided an interesting perspective on the subject, including the best ways to go about selling your business and some excellent advice on how to maximize the transaction.
SD&I: What are some financial and business management tactics to make a company more attractive or more profitable prior to a sale?
Michael Barnes, founding partner of Barnes Associates Inc., St. Louis,: “It’s important to know your metrics and how to create value for invested capital. There are four high-level metrics you want to be able to articulate and defend: 1). your cost to create new customer recurring monthly revenue (RMR); 2). profit margin realized on the RMR and related revenues; 3). RMR and customer attrition rates; and 4). speed of growth. These four metrics can basically define how value is created and at what rate.
Investors and acquirers also like defined opportunities that can be addressed with a crisp narrative that clearly says what your organization does and who you are. Our research supports the idea that companies both tend to perform better and realize higher market values when there is focus and clarity from the management team.”
William Schmidt, managing director, Security Lending Group, Capital Source, St. Louis: “I have found that the most successful companies in the alarm monitoring business focus on three important factors: originating high quality accounts at a reasonable cost (rational creation cost); providing excellent customer service to maintain a low attrition level; and providing monitoring and service in such a manner as to ensure a high margin on the recurring service revenue.
Companies that routinely put processes and reporting in place to manage these metrics typically result in superior cash flow positions.”
Ron Davis, founder and president of the Davis Group, Long Grove, Ill.: “The things that make an alarm company attractive to a potential buyer and which can be readily determined are: number one, good valid contracts for every customer complete with ample industry standard phraseology. Secondly, if the alarm company accounts are on their own telephone lines as opposed to a wholesale monitoring company’s telephone lines, because alarm company-owned lines are more easily moved. The third consideration is the company’s profitability, both from sales and from RMR. Finally, the fourth is account attrition, which relates to stability.
Delving deeper, potential buyers will want to determine how predictable the business is going forward (i.e. assimilation problems, etc.) and what economies can be extracted from the acquisition so that a profitable transition can take place sooner rather than later.”
SD&I: What kinds of things are investors looking for in companies they want to invest in/buy? What’s important?
Barnes: “Generally, investors are looking for companies that have a proven track record and a business model that is competitive, able to grow and is supported by an internal organization that is capable of handling the growth. Particularly important in today’s market climate are clearly defined operations and processes for creating investor value (i.e. metrics). Investors want to know what they are getting into and want their questions answered with supporting data. All things being equal, the higher value will generally go to the better documented opportunity.”
Schmidt: “While investors may indicate certain attributes that they find desirable, these attributes will almost always be based upon the fact that rational investors are looking for two things: strong operating cash flow (existing and post-consolidation economies) and the ability to predict that cash flow stream into the future. As such, the attributes needed include high levels of recurring revenue (improved ability to predict future cash flows) or high levels of growth (indicating higher levels of cash flow and improving margins).”
Davis: “For investors, the order of importance in most instances is management team, business opportunity (i.e. contracts, telephone lines, etc.), financial metrics (attrition rate, RMR, etc.) and the ability to ease the acquisition into the portfolio. In other words, an investor is looking for a solid, well-managed company that has dramatic growth potential both organically as well as through acquisition and investment in the platform.”
SD&I: What types of simple things can alarm systems integrators or central station companies do every day to boost the value of their company overall or in the eyes of the investor—or even for the bank where they might be going to for a loan?
Barnes: “Document, document, document. One can generally think of this in three areas, the first being customer agreements. Customer contracts must be current and enforceable. Information (i.e. names, addresses, etc.) contained within must be accurate, with clearly defined responsibilities for all parties. Next, documents that support internal processes should provide accurate and actionable information for managing the business with maintained underlying supporting data for verification. Lastly, financial statements should be in a standard format and have been professionally reviewed or audited.”
Schmidt: “The number one thing that an operator can do to increase the value of their company every day is to have excellent internal systems and reports. These benefits will be twofold. First, operations that are measured are typically better managed and improved; Second, measured operations are easier to demonstrate to third parties. A lack of proper internal reporting can affect a company’s ability to demonstrate financial and operating performance.
When it comes time to sell the business (or obtain external capital of any nature), any amount of uncertainty in the operating metrics of a business will be interpreted in as conservative (negative to the operator) a manner as possible.”
Davis: “As part of the process for selling a business or borrowing capital, it’s important for the owner to understand the financial mechanics. Both alarm companies and central station companies are sold/valued on a multiple of recurring monthly revenue. Typically for alarm companies of average size it’s in the mid-30s and for wholesale monitoring companies of average size it’s in the mid to upper teens. For integrators, it’s generally a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization).
To secure financing, the number one qualification is that the company can pledge assets that are greater than the value of the loan/investment. With regard to securing bank loans, lending sources will typically provide anywhere from 20 to 24 times the recurring monthly revenue even though the value of the accounts may be more. It’s important to note that banks differ from venture capitalists in that they are not looking for a return on their investment but rather only the pay back of the loan and interest charges.”
SD&I: What other kinds of things should integration companies be doing to add value to their business?
Barnes: “Getting the right support in place at the start of the process can save time and energy down the road. Industry professionals such as lawyers, accountants and advisors, who are skilled in this area, can be a valuable asset to an alarm company for helping to manage expectations or market the sales opportunity to the right people. A clear path to the finish line, achieved with the proper documentation and experienced support, adds to the company’s value and makes the process less stressful and time consuming.”
Schmidt: “Alarm integration businesses should be looking to increase the amount of recurring revenue derived from the installations. While the recurring revenue component for most integration businesses will usually be a minority of the company’s revenue, the value of the RMR base can quickly become important in terms of market value and operating cash flow.”
Davis: “When looking at the value of an integration company, one of the most important considerations is bottom-line profitability. Is the integrator making money on the systems and products they are selling? And secondly, does the integrator regularly negotiate for service contracts on the installations they perform to increase profitability from recurring monthly revenue? This latter item is probably the single most important consideration in relation to valuing an integration company.”
SD&I: Currently, what types of investors or others are looking at the security industry and how has this changed from the past?
Barnes: “Generally, there has been consistent interest in the industry from a consistent mix of investors. The recurring revenue component and the market’s sustained growth during the recession have helped to keep the industry attractive to investors. The impact of the recession however has made investors more conservative with an emphasis on investments that are more proven and less risky.”
Schmidt: “The physical security space has always experienced strong consolidation economics, which have led to consistent consolidation interest from the leading industry companies. What has changed over the past six years is the number of financial buyers, mostly private equity firms, which have discovered the great opportunities that exist in the security industry. In addition to significant capital, these private equity firms bring additional resources and discipline to the industry.”
Davis: “The types of investors who have come into the industry over the years have not changed dramatically. They do not have a high degree of risk tolerance and are looking for stable, cash-flow businesses. Many have come out of the cable, satellite dish or telephone industry and understand RMR. They are looking for a large platform company to get established in the industry. Today’s investors may be younger or even smarter but at the end of the day, they’re interested in a good operating company and that has not changed.”