Integrator or alarm dealer. Which one are you?
It is a completely different sale process if you are selling an alarm versus an integration company. The valuation process is different, the resulting valuations are very different, the buyers are different and many of the terms of the deal are different.
So if you are the owner of a security company, it is important to know what you are and therefore what you will be selling. Let’s define an alarm company as a company where the overall thrust is to amass monitored accounts or recurring monthly revenue (RMR). You may do some camera and access control work but these tend to be smaller jobs and not the main activity of your company. You want to build an alarm accounts base.
In contrast, let’s define an integrator as a security company where the thrust of the company is to sell, install and service larger commercial security systems, integrated or not. If you get a monitored account out of the installation that is a bonus but not the reason you did the job. In fact, many integrators consider installing or servicing monitored accounts as an unwanted distraction from the higher margin integration work.
Most company owners intuitively know what they are and where the value in their business lies. Of all the deals I have done, there has only been one deal where there was any confusion on this and interestingly enough that particular company did not sell. Why? Because both the owner and I thought there was value in the non-monitoring part of the company and that simply was not the case.
Here is a tip. A good way to determine whether there is value in the installation/service end of your business is to eliminate the monitoring revenue and accompanying costs from your income statement and see whether the rest of the business is still making money. Nine times out of 10 in the situation where the resulting income statement is not making money, the company for sale is an alarm company and the value of the company will be almost strictly in the monitored accounts. Do the test yourself on your own company and see what turns up. You can rest assured that most smart buyers will be doing the same test.
Integration companies are valued for the most part using a “multiple of normalized earnings” or “EBITDA.” The key items addressed to “normalize” earnings are any abnormally low or high owner’s compensation, any one time, large revenue or expense items or any large amortization, interest or bank charges expenses. For small and medium sized integration companies the multiples used to value the “normalized earnings” can be anywhere from three to six times depending on several factors: how fast the company is growing, how large the company is (larger companies tend to trade for higher multiples), and finally how “scalable” the company is. Scalability is a term used by private equity and investment bankers a lot and relates to the ability to “scale up” the company’s revenue to several times what it is currently doing.
Most of you have heard from me and others how alarm companies are valued. Although we all talk about multiples of RMR, the discerning buyers in this market will dig in to see what cash flow the account base will generate. They look at the monitoring rate of the accounts, the annual attrition rate, the cost to replace lost accounts and the cost to service, bill and collect the accounts amongst other things to determine what that number of months should be. Today more and more, particularly on larger account bases. buyers will calculate what they call “steady state net operating cash flow” (SSNOCF). This calculates what cash flow the account base drives after replacing annual attrition. Finally, two factors that don’t get into the SSNOCF calculation but are very critical in assessing any account base are: the accounts have signed contracts and are on a call forward line.
If I owned an alarm company I would do the following to maximize the value of my company. Own as many accounts as I can — whether I get them organically or buy them — have them located in as dense a geography as I can, make sure the average monitoring rate on the accounts is $25/month or higher (this affects the cash flow calculation hugely), manage my net attrition so that it is for sure below eight per cent and preferably below six per cent, have them all on signed contracts, all on a call-forward line and as many on PAP as possible.
If I owned an integration company, I would do the following to maximize my selling price: do business in a niche where the margins are 35 per cent and above, make sure that niche has lots of future business in it, try like crazy to get my business to as close to $10 million per year in revenue, make sure it can stand on its own without needing me, make sure that I am staying up-to-date with technology all the way through my organization both in what I use to run my business.
Finally, the buyers for each type of company, are for the most part, completely different. It pays to know what you are and to maximize the factors that build value in that market.
Victor Harding is the principal of Harding Security Services (www.hardingsecurity.ca).
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