Peter Flynn, Managing Director, Mark Sandler, Managing Director, Security Performance Partners, LLC
As an alarm company owner, you are probably interested in knowing and understanding the market value of your company. This value is primarily a function of the market value of your alarm accounts.
By definition, the market value of a company’s assets, including alarm accounts, is the most probable price those assets should bring in a competitive and open market under all conditions requisite to a fair sale, the buyer and seller each acting prudently and knowledgeably, and assuming the price is not affected by undue stimulus. With that said, there are several factors that impact what a buyer is willing to pay.
In our industry, valuations are often measured by a multiple
of recurring monthly revenue, or RMR. However, the critical financial factor in valuation is the cash flow that the assets of a business generate. One common measure of cash flow is EBITDA, Earnings Before Interest, Taxes, Depreciation and Amortization. This is a measure that calculates the cash generated by the assets before the payment by the owner or the business for interest on debt, for taxes, and for accounting adjustments. It is the measure of the net cash that the assets would generate for a buyer when these assets become part of the buyer’s business. Buyers may make additional adjustments to this number for the creation costs necessary to replace attrition in an account base. The buyer may also calculate incremental cash flow, or the cash that the accounts or assets will generate after economies of scale are realized post closing. Sellers should not expect, and is is unusual for buyers to give, the full benefits of these economies of scale when valuing assets.
Because the key financial factor in valuation is cash flow, there is often not a significant.distinction made between the valuation of all of the assets of the business and the primary assets being acquired: the alarm accounts. In the instance where a significant foothold is being established in a market, which a buyer could not otherwise efficiently achieve, a premium of multiple may be applied. In this case, a buyer may require the purchase of all of the assets of the business, in order to be able to service the accounts on an ongoing bseis. In any event, in most acquisitions, the buyer may require a minimum amount of assets (inventory, vehicles, etc.) to be included in the sale to eliminate the need for additional cash expenditures by the buyer post closing to service customers. In addition, it is important to note that all RMR is not equal. RMR associated with monitoring creates more cash flow than monitoring that is associated with service agreements.
With cash flow beng the key metric, the quality of RMR and alarm accounts (the key cash flow generating asset) is critical. Several factors are considered in evaluating the quality of RMR. Accounts Receivable aging is a key indicator of RMR quality. Buyers will evaluate the accounts receivable based on the number of days from due date that customers take to pay their bills. Typically, buyers will consider customers aged fewer that 60, or 90 days as having good or “qualified RMR.” Typically, RMR with aging over 90 days is not valued. In addition, account bases that have large numbers of customers that continually are over 30 days tend to be discounted in terms of value.
The quality of the underlying contracts for customer accounts is also critical. Written, signed contracts with key legal language are critical. Contract lengths vary, but buyers typically will look for minimum terms of of 36 to 60 months with evergreen or automatic renewal language in jurisdictions where this is legal. In established companies, buyers may accept shorter lengths of contracts for customers that have excellent payment histories for several years. Owners should consult an industry attorney if they have questions with respect to their contracts.
The key measure of RMR qualtiy is attrition. Cash flow is reduced by the cost to create replacement accounts. Low attrition is indicative of several quality characteristics in a customer base including the initial consumer underwriting done at sale, quality of service, and quality of installations. The lower the attrition in an account base the higher the cash flow and the higher the valuation.
The ability to have access to meaningful, well organized information also impacts the value of a business. The ability to obtain accurate and timely information regarding an account base gives a buyer confidence that they know what they are buying and eliminates the fear of the unkown. Owners of businesses should invest in accounting and financial reporting systems for their own benefit and well in advance of contemplating a sale. In addition, contracts and service files should be up to date and kept in accessible, organized fashion.
Other operational factors will contribute to value. Consistent, quality installations with quality product reduces service cost and increases cash flow. In cases where a third party central station is used, accounts should be exclusively programmed to phone lines controlled by the account owner. In the event of a sale, the transition cost of reprogramming accounts if it is necessary will reduce the value of the accounts.
All of these quality factors will also impact the terms at which a buyer will purchase assets or accounts. Holdbacks and RMR guarantees are typical in transactions in the market today. However, the amount and length of the holdback, and the terms of the guarantee, are all impacted by quality factors.
Owners of alarm businesses that focus on these quality factors will have assets that generate good cash flow. These types of businesses will always be of premium value to buyers.