Tips for navigating more complex deals
I have been quite busy recently doing valuations and closing some deals, which is great. Being so busy also means that I learn things on almost every deal I do. Here are some of my latest tips.
By Victor Harding
Selling an integration or fire company takes much longer than selling an alarm company
This may seem obvious, but I have experienced this first hand. Think six months for selling a decent sized alarm company from start to finish and almost twice that for an integration or fire company. In my mind, this is partly because there is not as much of an established market or the same number of obvious buyers in Canada for integration or fire companies as for alarm companies. You can sell monitoring recurring monthly revenue or RMR. Installation and service revenue are more difficult.
Most buyers of shares expect to get working capital included in the deal
When working for Voxcom and Protectron, helping them buy alarm companies, we very seldom cared if the seller gave us working capital in the deal or not.
Working capital is made up of all those current assets and liabilities at the top of the balance sheet and generally includes cash, accounts receivables, inventory, prepaid expenses, account payables and accrued liabilities. Most of the time, we preferred it if the seller’s balance sheet was completely zeroed out and just left us the deferred revenue.
As I learned later, this is unusual and relates partly to the fact that the buyer does not plan to continue to operate the company as a stand-alone business and partly to the fact that the monitored accounts will be folded into the rest of the buyer’s account base with very little added cost. With most buy-out situations, buyers of shares, and even sometimes the assets of a company, will expect to get some working capital included with the price they offer for the business. Many owners of small businesses are not ready for this and think that they are giving up money when they have to turn over the business with working capital in it. This is simply not correct. Buyers offering a price for the shares of the business should not expect to have to write a cheque to fund the activities of the business immediately after buying it. Another way of looking at this is, the buyer is buying the entire business including all the working capital in buying the shares.
How much working capital a buyer gets upon closing is a science in itself and usually needs an analysis on what working capital the business generally needs day in, day out to operate.
One more important point to keep in mind when calculating working capital is expect that the buyer will include any of the business’ deferred revenue at the time of close, whether you normally calculate it or not.
If your deal requires your buyer to get a bank loan, count on adding months to get the deal closed
Again, this may seem obvious, but generally it does not come up when the buyer is examining the prospective business or even when an offer is put forward.
Getting a loan from the Canadian banking system to buy a company, no matter how good the asset you are buying, takes time. Secondly, often the security for the bank loan is the seller’s operating assets. So, the better the seller’s company, the easier it should be to get the loan.
When all is said and done, most integration companies don’t actually make that much money
This was a shocker to me. Truthfully, this is just a generalization I learned from talking to someone in the U.S. who deals with integration companies all the time.
Originally I thought it was just the integration businesses I was selling that were the problem. I sold one integration business two years ago that was doing more than $5 million in revenue annually but only making about $500,000 per year in net operating profit. I later found out that 10 per cent operating profit for an integration company was actually quite good and many only make five per cent of total revenue per year. Those making 10 per cent or more most likely have a sizable base of monitored accounts or other recurring monthly revenue. The only answer I can give for that lower profitability is pure competition.
The market has a way of re-establishing itself
For a while there, I was worried because many of the bigger buyers of monitored accounts in Canada had either been bought out or were not buying. VOXCOM, Protectron and Microtec were gone. ADT and Counterforce were simply not buying alarm accounts. I needed more buyers. Well, the wheel has turned and Counterforce and ADT are back in the game looking for accounts to buy. On top of this, there are at least two new, potentially national, buyers on the scene now looking to buy alarm accounts. The buyers for alarm accounts are there again.
Rushing a deal’s closing almost never works
If you are just selling alarm accounts and nothing else, it is possible, with planning, to close a deal quickly — although even the simplest deal will probably take at least two months to close. Buyers like to close at month’s end. However, if you are selling shares of your company and the buyer wants to operate the business as a branch office or standalone business afterwards, the deal will almost always take more time to close. This is particularly true if the seller is going to be working for the buyer. You have to do extra due diligence because it is a share deal. You will have to make decisions about working capital, employment agreements and other staff decisions.
Victor Harding is the principal of Harding Security Services (firstname.lastname@example.org).
This article originally appeared in the August/September 2018 issue of SP&T News.