As the security and alarm sector moves beyond the impact of the pandemic, what can be expected in the lending environment ahead? We are seeing several shifts that may be informative to a security integration business.
What’s Changing
Banking environment: First and undeniably so, the banking environment is changing. Some major banks that have traditionally lent aggressively to the sector are exiting, while other banks are joining with more disciplined lending.
Loan structure: Another consideration is “club transactions,” or loans that are divided among several banks. With access to capital generally more challenged now, it is not unusual for larger security and alarm companies to find themselves working with more banking partners because a bank’s willingness to lend a higher amount, solo, is becoming more restricted.
M&A activity: The security and alarm sector is also experiencing increasing merger and acquisition activity. Generational transitions are one reason. The regular cycle in the broader market – where business founders near retirement and opt to exit their companies through M&A – is carrying through to security alarm companies as well. It is an opportunity for well-positioned companies to access capital and leverage a strategy to grow through M&A during a unique period in the company’s evolution. Traditionally, companies that have managed their financials and debt well, and demonstrate strong balance sheets, are in the strongest position to acquire.
Changes in Lending and Falling RMR Multiples
Some characteristics of lending are also evolving. For example, advance rates on recurring monthly revenue (RMR) are coming down. In some cases, they are decreasing by many multiples of RMR. Lower advance rates tend to coincide with limited access to capital, and that may translate into potentially less capital being available to borrow.
Being well positioned in today’s environment means demonstrating solid RMR and cash flow. RMR has been a long-standing loan criteria; now, a company’s core ability to generate cash flow to pay down debt and deleverage also figures prominently.
We are seeing that companies exhibiting these characteristics are capitalizing on the opportunity to be a buyer rather than a seller in M&A transactions. In addition, during due diligence and as a factor to evaluating a company’s ability to repay debt, some banks are focusing more on a company’s actual cash flow and EBITDA generation, rather than adjusted cash-flow and their ability to deleverage.
5 Ways to Capitalize on the Banking Trends
With all this at play, what can security integrators and alarm companies do to position their businesses favorably? Whether during acquisitive times as we are seeing now or other periods, consider these five ways to position a business soundly from a financial perspective:
1. Deploy good underlying financial reporting and financial controls. A banker or financial advisor can suggest best practices to operationalize for your business.
2. Create a strong due diligence package that you can share with a bank. If you were to describe the story of your company, what would you say? Descriptions of your company, its history of how it began and has evolved, the markets it serves, and its commercial and residential product lines are all helpful information to provide to a financial institution to better understand the business. This information, coupled with solid financial reporting, creates a strong due diligence package. If you are developing this information for the first time or simply looking for guidelines, work with a financial advisor who can help.
3. Be prepared for a field exam. If you have strong financial reporting and a solid due diligence package, you will be well prepared for a field exam that is designed to validate the underlying financial condition of your business. The field exam is required by banks as part of their due diligence process.
4. Leverage an experienced financial advisor who is knowledgeable about the sector. Financial advisors can be connectors to banks that may be good fits depending on your business needs. Ask a banker or consult a trade association such as The Monitoring Association (TMA) for their recommendations.
5. Add an industry attorney to your team of advisors who understands M&A transactions, the nuances of the sector as well as the full suite of options available to your business.
With these ideas as part of standard operating procedures, security companies will be demonstrating solid financial protocols and good business controls. Look to the past year as an example: When the pandemic changed everything in our lives, having these practices in place likely created some sense of stability amid the most challenging of times.
Greg Buscone is EVP and Senior Commercial Banking Officer at Boston-based Eastern Bank (www.easternbank.com), with responsibility for its Commercial & Industrial lending portfolio, which includes business customers focused on security systems and alarms. Contact him at [email protected].
