11.18.24 – Ken Kirschenbaum
Buyers come in a few varieties: those who have the money, those who use other people’s money and those who borrow the money.
Although many sellers express concern for their employees and customers, which is genuine, the bottom line usually boils down to this: What’s the multiple?
For the uninitiated, “the multiple” refers to the number that is used to multiply the recurring monthly revenue (RMR). It could be expressed in years, but the custom in the alarm industry is to use a monthly multiplier.
Finger on the Pulse of Multiples
Alarm owners like to keep their finger on the pulse of the current multiple in the industry, even though that multiple doesn’t really change all that much.
The multiple can be low — say, 15 to 25 times RMR — for accounts with no (or poorly drafted and executed) contracts, archaic systems that require upgrades, or an overly risky or difficult to service customer base. Of course, there could also be other reasons.
The multiple can also be at the higher range — 35 to 45 times RMR — which is usually because the contracts are up to date, the customer base is diverse and stable, the RMR is reliable or for other reasons.
The typical deal is structured with cash at closing — between 80% and 90% — and a one-year guarantee with part of the purchase price held back. This is the infamous “holdback.” The holdback is sometimes funded by the buyer and held in escrow by one of the attorneys on the deal.
It could also simply not be paid at the closing and instead be paid once the guarantee is over and a final calculation of the purchase price is made.
How much a seller is paid and how much the buyer pays (yes, it’s the same number) depends on so many factors that each deal really has to be evaluated independently of all others.
The buyers out there who “have their way of doing it” are probably not bothering to do a deep dive evaluation. That’s fine; they can afford to make mistakes. But most alarm companies want to be careful when deciding what they will buy and how much they will pay for it.
Varieties of Approaches to Multiples
Buyers come in a few varieties: those who have the money, those who use other people’s money, those who borrow the money from banks or lenders in the alarm industry, and those who borrow from the seller.
How does seller financing work, and why do buyers love it? There are a couple of reasons:
Seller financing basically means that the seller does not require the customary cash at closing and adjustment after one year; instead, the seller permits the buyer to pay the purchase price over a fixed period of time, which is usually three to five years.
What’s in it for the seller? Well, the seller will typically get more money for the purchase price — the multiple will be higher. Also, the payout will carry interest. It has to, and it will. (So, don’t even think about a payout with no interest. The IRS insists on it.)
The interest on the payout will more than likely be more than the seller would be able to get if they received the money and then invested it in a safe investment. Treasuries are paying 4.5%. Same for CDs. Municipal bonds are 3.4% or so. And higher-risk investments in equities can deliver more, depending on the liquidity and risk factors.
Buyers who have to borrow tend to like seller financing because the interest rate will likely be less than a lender would charge, so the interest rate sort of benefits both parties.
Sellers need to assess the risk in the investment, which centers on the assets of the buyer. Although a seller may not need to ask whether they would be willing to make a loan to a buyer if there wasn’t a deal, sellers do need to be careful when evaluating the buyer.
Risky Buyers
Risky buyers might include those with no assets or business who want to buy into the industry. They could also include buyers who, despite their size, are in debt up to their neck and just need to keep growing and borrowing to stay on course for their model or business plan, hoping the house of cards doesn’t collapse.
Buyers who are worthy of seller financing also exist. They are financially stable, and a seller can feel comfortable that such a buyer will be able to make their payments on the loan.
Seller financing permits the seller to spread the tax consequence of the sale over the time of the loan because tax is incurred in years that money is received. There may be other tax considerations that I can’t and won’t opine on. (That’s what the tax guys are for.)
Buyers like seller financing because they feel more secure with the purchase. With a five-year payout, for example, they are essentially paying the seller with the revenue generated by the seller’s accounts, which, of course, assumes that the buyer will retain the accounts.
Buyers are also a bit more comfortable accepting all the representations and warranties that sellers have to give in the sale agreement because they feel they are holding the money owed to the seller for longer than a one-year period.
Representations Are Backed Up
They also feel that the seller’s representations are backed up by more than the negotiated holdback, which is also usually limited to the attrition guarantee. (At least, it will be if K&K is your attorney on the deal.) Seller financing could add as many as five points to the multiple — so, instead of getting 35X, you would get 40X. The seller needs to decide if the risk of lending is worth it.
There’s so much more that needs to be considered when selling your company or buying a company. The best advice I can leave you with is this: Call K&K…sooner rather than later.
About the Author
Ken Kirschenbaum, SSI Contributor
Security Sales & Integration’s “Legal Briefing” columnist Ken Kirschenbaum has been a recognized counsel to the alarm industry for 35 years and is principal of Kirschenbaum & Kirschenbaum, P.C. His team of attorneys, which includes daughter Jennifer, specialize in transactional, defense litigation, regulatory compliance and collection matters.