On March 13, 2020, President Trump declared a U.S. national emergency due to the coronavirus. By March 17, the virus was present in all 50 states. People suffered, many died and continue to do so. Isolation and quarantine orders led to non-essential businesses being shut down.
Many businesses went bankrupt, and that liquidation sadly continues. Those businesses that continue to survive have materially altered their operations to comply with government mandates and for the protection of the health, safety, and welfare of employees and others.
Given the epic struggles of humanity across the globe with the coronavirus, it seems callous to highlight COVID-19’s effect on what was a red-hot account acquisition marketplace before the pandemic; however, we live in a capitalist economy and, as such, the welfare, security, futures, and dreams of all of us are intertwined like a finely woven web in this market-based economy.
The Pre-Virus M&A Landscape
Prior to COVID-19, the security and alarm account acquisition market had been red-hot for years; although it was softening a bit to accommodate the residential DIY market. Still, properly contracted, rightly priced and timely paying central station monitoring accounts, fire alarm inspection accounts and profitable service plan accounts were in high demand.
Buyers exceeded sellers by an order of magnitude; it was a sellers’ market, and it was not unusual for a prudent, disciplined and well-managed seller to have multiple offers. Multiples for RMR held firm; holdback demands from buyers remained reasonable. Interest rates were low. Due diligence and preparation of the transactional documents for closings were timely and efficient.
Buyer acquisition financing from lenders was generally available at attractive rates, although some lenders were pulling back before the coronavirus outbreak due to uncertainty and concerns emerging from the DIY market.
DIY: A Threat Before and After
The DIY market was, and continues to be, a test of the strength of the account acquisition market, at least for residential-based monitoring accounts. The concern from buyers in the traditional residential security space is that global competition from the DIY market will increase attrition and compress margins for central station monitoring as global DIY leaders reduce monthly monitoring fees to subscribers to compete with traditional security and against each other.
Paradoxically, however, DIY has, in my experience, had only minor impact on the residential account acquisition market. Even before DIY, a traditional security company had to replace annual account attrition just to stay even, let alone grow.
Given competition from DIY, the need for, and amount of, attrition replacement increased, and continues to increase. A traditional security company looking to replace that attrition can do so through organic growth by having its sales team hit the pavement in search of new accounts. Such organic growth is getting more and more challenging – and expensive – as competition increases from DIY and other traditional security companies looking to fill attrition and employee wages and benefit packages increase.
Alternatively, a traditional security company looking to fill its attrition or grow can do so through acquisitions of high quality and properly contracted accounts from sellers. Since the creation multiple for organic growth seems to exceed – by several points – the industry standard RMR multiple to buy an account base in the acquisition market, the demand for a high-quality portfolio of residential central station monitoring accounts has remained stable despite the DIY competition, as have the RMR multiples payable by an able buyer.
Immediate Effects of COVID on Acquisitions
If DIY was a gut check on the account acquisition market, the coronavirus has been a full-blown trial. As the coronavirus spread, buyer searches for target acquisitions came to a halt. Pending transactions returned to the negotiating table, as buyers sought to reduce multiples, increase holdbacks to offset risks of greater attrition, and extend out closing dates pending some visibility on the state of the world.
Where contractually permissible or agreed to between the buyer and seller, some pending transactions were cancelled. In short, the outbreak of the coronavirus sent the account acquisition market into its own self-quarantine.
As an attorney specializing in the security alarm, life-safety industry and closing several account transactions annually for buyers and sellers, I had four pending transactions in or around March and April 2020:
- Transaction 1 was in the due diligence phase, with a letter of intent signed by the parties, but no signed asset purchase agreement. The buyer in that transaction elected to terminate the transaction and has not since re-started discussions with the seller.
- Transaction 2 had a pending closing date with an asset purchase agreement signed between the parties, with the closing schedules and exhibits near completion. At the buyer’s request and the seller’s cooperation, the closing of that transaction was extended for 90 days and has since closed with no adjustments to the RMR multiple or the holdback.
- In transaction 3, a letter of intent was signed, due diligence completed, and the parties were negotiating the terms of the asset purchase agreement with a competitive RMR multiple and industry standard holdback percentage. The buyer went back to the negotiating table with the seller and demanded a 20% reduction of the RMR multiple and a 10% increase in the holdback. After some negotiations, the parties decided to part ways and the transaction has not since resumed.
- Transaction 4 involved an agreed upon 10% reduction of the RMR multiple and a 10% increase in the holdback percentage and closed in April of 2020.
Other industry attorneys, brokers and buyers have shared with me that their experiences over the past several months have mirrored mine.
COVID’s Effect over the Longer Term
Since July, I have noticed the account acquisition market slowly returning to its pre-coronavirus health. Transactions – new and pending – are moving forward in the ordinary course, according to fellow industry transactional attorneys, brokers and seasoned buyers.
Safety, security, and peace of mind are basic archetypal human needs. During uncertain times caused by natural or human-made disasters, the psychological need for safety and security can be a boon to the security alarm/life-safety industry and continue to fuel the related account acquisition market; however, while RMR multiples seem to be holding firm at their pre-coronavirus industry averages, some buyers are demanding higher hold-back percentages – roughly an additional 10% in my experience – to offset likely increased attrition as more businesses fail, and some consumers become no longer able to afford or justify monthly monitoring fees.
Similarly, buyers have tightened up due diligence to hyper-focus on a seller’s account base in higher-risk market sectors, such as restaurants, bars and retail, and they have adjusted RMR multiple offers to sellers and holdback requirements accordingly to offset this hidden attrition risk.
Overall, however, buyers are becoming more hopeful that “this too shall pass” and the power of human ingenuity will lead the way. Further, the coronavirus has made it that much more challenging and costly for traditional security to fill embedded attrition and grow organically; that is, the creation multiple for new accounts continues to escalate as new customers searching for traditional security in these challenging and uncertain times become more scarce.
Thus, as long as a buyer can purchase a well-managed, profitable and well-positioned existing account base in the acquisition market at an RMR multiple that is materially discounted to its creation multiple – and offset some residual coronavirus related risk through increased holdbacks and tighter due diligence – the account acquisition market should continue to heal and return to its pre-coronavirus health.
Michael J. Revness, Esq., is “Of Counsel” and chairperson of the Security Alarm/Life-Safety Industry Practice Group at the law firm of Kurtz & Revness P.C. (www.kandrlaw.com). Contact him via email at [email protected] or call (610) 688-2855. This article is for information purposes only and does not constitute, and should not be relied upon, as legal advice.
