The proposed purchase of ADT for $6.94 billion is just another indication that there are investors seeking to enter or enlarge their presence in the electronic security industry.
“With growing concerns about safety and security, solid cash flows, service and monitoring contracts and evolving new technology we predict there will be more consolidation and opportunities for more profitable consolidation in the industry,” says Mark Breheny, Vice President of Generational Equity, an M&A advisory firm that works with middle-market business owners.
“You don’t have to be a giant public corporation to receive full value or even a premium for your security business,” adds Terry J. Mackin, Generational Equity’s Managing Director of Mergers & Acquisitions. “The ADT deal is an example of one type of buyer who wants to expand their presence in an industry,” said Mackin.
The ADT acquisition was made by Apollo Group — which plans to combine ADT with its Protection 1 holdings (read more at www.securityinfowatch.com/12170608). “Private equity acquisitions are not limited to huge corporate deals,” says Musa Jagne, Generational Equity’s Vice President. “Smaller companies can leave money on the table if they do not cast a wide enough web in their search for buyers that includes private equity firms along with other likely purchasers.”
Apollo’s prepared statement announcing the ADT acquisition indicates there are more opportunities ahead for consolidation in the security services industry. “This transaction provides the opportunity to dramatically enhance our position in the large, fragmented and growing residential and business interactive electronic monitoring industry,” Marc Becker, Senior Partner at Apollo, said in the statement.
Getting Ready to Sell or Seek Investors
There are many reasons business owners decide to sell or partner with investors. Some want to retire, others want to diversify their personal assets and not have to personally guarantee company debt. Some who want to continue to work need outside capital to take their company to the next level. Taking the time to research the process, working with skilled professionals and getting your business ready to sell are keys to obtaining the financial rewards that come from years of hard work.
Before any business enters the market looking for buyers, it is vital that the current ownership have an accurate idea of the value of the company. A key part of this process is recasting financial statements so they adequately depict the true profitability of the company and accurately project revenue and earnings for five years into the future. Recasting earnings means removing items that are superfluous, excessive or discretionary expenses as well as non-recurring revenues and expenses.
“Professional buyers are buying your future, not your past,” Breheny says. “The only way to accurately highlight your future profitability is by recasting your historical past and then projecting out five years using the new recast baseline as your starting point.”
Another important step is creating a list of intangible assets that may interest more buyers or help provide an incentive for someone to pay a premium price for the company. Such items can include: key customers with long-term contracts, valuable employees, location, subscriptions or service contracts and franchise agreements.
The Offering Memorandum
“A seller will not receive full value for the company by offering buyers just a set of financials,” Mackin says. “A comprehensive offering memorandum makes a more compelling case to a potential buyer or investor.”
A complete offering memorandum includes:
- A thorough description of a company focusing on intangibles and what makes it unique;
- The full history of the company, especially any significant events in the past five years;
- A detailed examination of the organization, focusing on key employees — what they do and why they are important;
- An in-depth examination of key customers, who they are, and the firm’s relationship with them; and
- A comprehensive overview of where the company is heading during the next five years, and what it will take to get there in terms of capital and people.
This information is also refined into a profile letter, which is a two-page summary provided to prospective buyers or investors to get their attention. “Once potential buyers have received the profile letter and have contacted the company, it needs to have them sign a very strong confidentiality agreement prepared by an attorney who specializes in mergers and acquisitions,” says Brad L. Whitlock, an attorney with the law firm of Scheef & Stone, LLP.
Who Will Pay a Premium for Your Business?
Depending on an investor’s strategy, some will pay a premium for a company. As the ADT acquisition illustrates, some buyers are willing to pay a premium if an acquisition meets an investors strategic goals. “This transaction represents a highly attractive premium for ADT’s shareholders,” said Naren Gursahaney, President and CEO of ADT. “By combining Protection 1 with ADT, we will be better positioned to expand the breadth and depth of the services we offer to our customers throughout the United States and Canada.”
It is a mistake to think that a local or regional competitor is the most logical buyer for your company. In some cases, this may end up being the optimal buyer; however, assuming this at the outset mean eliminating a large group of potential buyers. Additionally, a “limited auction” is where two or more buyers interested in your company all bid against one another, which only does one thing: raise your value.
Structuring the Deal in Your Favor
Often, sellers become fixated solely on the purchase price while neglecting the importance of the overall deal structure. Mistakes in structuring a transaction can significantly erode the hard-fought value the seller has managed to negotiate. For an owner that is interested in remaining partially involved in the business after the sale, structuring a proper earn out or employment agreement can add significant value.
For a seller that desires only partial liquidity, structuring a stock transaction enables the business owner to realize monies over time and capitalize on favorable tax differed treatment. Creating an optimal deal structure includes three interrelated components: negotiations, forms of payment and taxes.
“Holding out for an all-cash deal can also be a major mistake and cost the seller money,” Jagne cautions. “Sometimes an all-cash deal is not the optimal deal structure. Deals can be structured using a variety of forms of payment including cash or secured notes, retained equity, stock in a public company, non-competes, consulting and employment agreements or cash equivalents (assets that are readily convertible to cash).”
Taxation should also be taken into consideration as the deal is structured. When determining the consideration that will be received from the sale of the business, it is important to understand the tax implications of the various options.
From a tax standpoint, there are generally two ways to complete a deal: asset sale or stock sale. In an asset deal, the seller is paid for the assets of the business and retains specified liabilities. From a tax perspective, an asset deal may translate into a large upfront tax liability for the seller. In a stock deal, the seller is paid for the company’s shares and does not retain any liabilities. If paid in stock, the seller has the ability to take advantage of long-term capital gains tax rates by retaining the buyer’s stock over a period of time.
David S. Margulies is president of Margulies Communications Group. Reach him at [email protected].
