Your Guide to Alarm Company Acquisitions and Financing
Sponsored by Securex Financial Corp.
Recurring month revenues and cash flow are two business terms every security alarm dealer in Canada should be familiar with.
The motivation for a security alarm dealer to acquire the monitored accounts of a competing dealer or the shares of a competing dealer’s company is primarily to increase its RMR and associated cash flow, however the rational may also include:
1. Eliminating a competitor;
2. Achieving greater geographical coverage;
3. Increasing account density in a given market in order to:
a) Achieve lower per unit service costs and,
b) Increase exposure through decals and lawn signs, thereby generating more low-cost referral business and enhancing the goodwill of the business;
4. Invest in new technology in order to gain greater participation in a growing industry, enabling benefits such as:
a) The ability of the customer to operate the system and view activity at the protected premise from a smart phone and,
b) To upgrade existing accounts so that the customer may take advantage of the enhanced system functionality made possible by technology;
5. Reducing back office administrative activities associated with customer billings, collections and accounting so that the dealer may focus on new system installations, upgrades and customer service.
The security alarm industry is highly fragmented with several thousand independent dealers operating in Canada. The larger dealer is often motivated to acquire the smaller competitor for the aforementioned reasons. Many of these smaller dealers, even though they may have hundreds of accounts, are only marginally profitable.
These businesses are unable to provide a sustainable income to the owner and the owner may accordingly be motivated to sell to a competitor. The smaller dealers, because of their higher per account costs, often find selling accounts very attractive as the example below illustrates:
The purchase price for a portfolio of accounts may vary based on a number of factors, including: 1) Signed monitoring agreements; 2) Term of agreement; 3) Auto renewal of agreement; 4) Pre-authorized payment provision; 5) Credit scores; 6) Accounts receivables aging; and 7) Type of equipment installed (age, ability to service, system functionality).
Many of the smaller companies in the industry are motivated to sell their accounts or companies to not only ease the financial strain they may be under but also, in the case of a share sale, to avail themselves of the favourable enhanced capital gains tax under the capital gains exemption.
A share sale would typically result in a lower purchase price because the shares cannot be written off (amortized) against income by the purchaser, as is the case with the sale of accounts. However, the after-tax net purchase price to the seller may be greater. The purchaser may also be reluctant to purchase shares because of the heightened due diligence required to determine the veracity of the company’s assets and liabilities.
The seller of shares, being a “Canadian Controlled Private Corporation,” may be in a position to take advantage of the enhanced capital gain tax rate resulting in only 50% of the gain being taxable and when combined with each owners “lifetime capital gain exemption” of $866,912 may result in little or no tax being payable by the seller on the proceeds of a share sale. When investigating tax matters for your business, please consult your professional tax advisor.
Alarm companies may also be motivated to acquire competitors in order to gain technical expertise that doesn’t exist within their own organizations. For example, companies may wish to acquire dealers with access control, CCTV or interactive services capabilities, which will allow them to enter these markets through an established, profitable platform. Alarm accounts are typically quite sticky and competitors have met with only limited success in taking over accounts due to written 3 to 5 year, auto-renewing monitoring agreements.
A competing dealer has to advertise or employ door knockers to locate a reasonable amount of these customers. This is an expensive and difficult barrier to overcome. When compared to the complications and expense of luring a customer out of an existing monitoring agreement and trust relationship with the installing dealer, dealers opt to solicit the many households that do not have security systems or will attempt to acquire a competing dealer or their account portfolio. These customers are generally not motivated to incur the inconvenience associated with entering into a new relationship with a dealer and monitoring stations for small price reductions or other incentives, which could in any event, be matched by the incumbent dealer, resulting in considerable expense and no benefit to the competing dealer.
A dealer may also increase the value of his business by adopting account attrition management strategies. These strategies include corresponding and communicating with customers in order to provide them with additional information on the benefits of their system and reinforce the relationship and encouraging the customer to take advantage of cellular phone functionality in order to, among other things:
a) View their home remotely;
b) Moderate lighting;
c) Change heating and cooling settings; and
d) General interaction with their system.
By adopting these and other attrition management strategies — together with internal administrative systems to track customers who have cancelled systems — the dealer is able to grow its account portfolio as a result of attrition. Furthermore, the larger the account portfolio the greater the number of referral installations a well-managed portfolio will generate, thus resulting in a low-cost vehicle for internal growth. Enhanced system functionality and attrition management strategies combined with overall industry growth means the dealer is well positioned to profitably grow the business.
The challenge for all but the largest players in the industry is the inability to finance internal growth or acquisitions, as traditional funders (such a banks and credit unions) are asset-based lenders and do not recognize the dealers’ most valuable asset — its account portfolio — as collateral for loans.
Leonard M Sudermann is the President and CEO of Securex Financial Corp. (www.securex.ca)