Raising Money

Why alarm companies must be financially solvent

An electronic security and fire alarm company can be a great business for many reasons, including the ability to be successful at a range of company sizes or the fact that barriers to entry can be fairly low. An alarm dealer doesn’t have to design and build his own systems or his own monitoring center. These “raw materials” of an alarm company’s services are readily available from numerous and varied excellent manufacturers, distributors, wholesale central stations and dealer programs, making entry into the industry relatively capital un-intensive.

In the alarm industry, it’s not getting in that’s difficult—it’s staying in. Staying in is what requires alarm companies to raise money. One of the main reasons for this is that many dealers, especially those focused on the residential and small commercial markets, have to sell and install systems at a loss in order to compete with other companies for the lucrative recurring monthly revenue (RMR) that comes from monitoring those systems.

Even if a company is able to charge enough up front to recover the costs of their new sales and installations—or perhaps they have enough positive cash flow to cover those costs—nearly every business eventually needs to raise capital. It may be to buy out a partner, open a new office or acquire another alarm company.

Different Types of Financing

Fortunately, there are several avenues alarm dealers can take to raise funds. Strategies generally fall into three categories: sell a portion of the company, sell assets, or leverage assets to borrow.

Sell a portion of the company. Taking on equity investors can be a risky proposition. For the small business start-up, this usually means friends and family. And, as the saying goes, “before borrowing money from a friend, decide which you need more.” The advantages to raising money through investors are that they take the risk, they don’t require ongoing payments and they understand they may not get paid back for a while. The disadvantage is that the company owner now has partners, who expect to have a say in how the company is run and receive a share of the profits.

Sell assets or accounts in bulk. Because subscriber contracts that generate RMR are transferrable, security and fire alarm companies have the option of carving off a portion of their customer base and selling those subscriber accounts and contracts to another alarm company. This can be a local competitor or a large regional player, or to a company that will take over receipt of only the monitoring revenue and allow the dealer to retain the direct service relationship with the customer.

Sell assets, newly created accounts. One common way that alarm companies raise money is by participating in “dealer programs,” where they act as an agent of a larger company and sell off the customer monitoring contracts as they are signed, often on a weekly basis. While this type of funding serves the purpose of providing much needed cash flow to a company that incurs significant costs creating new accounts, it doesn’t do much toward achieving a goal of accumulating RMR. However, depending on the terms of the funding program, the dealer may have the option to get some or all of the accounts back after a period of time.

Leasing. This method of raising money is really about providing capital to the customer rather than to the alarm dealer. However, it can achieve the same objective of covering the up-front costs that come with obtaining a new customer, such as equipment, installation and in some cases, service and monitoring, while the customer pays the leasing company over time.

Loan financing. Many people view debt as a bad thing, boast about not owing anyone for anything, or claim as a badge of honor that they’ve never had to borrow. The message that debt is inherently bad is reinforced by the negative context in which we discuss the growing national debt, the burden of student loans and the seemingly inexorable nature of credit card debt.

But raising capital through debt, or loan financing, may be the most financially prudent method of gaining cash flow. There are expenses associated with borrowing in the form of interest and loan fees, but these costs may be significantly lower than the cost of lost future revenue when RMR accounts are sold.

Loan financing can be obtained from friends and family, from traditional banks and fortunately, in the case of our industry from “specialty lenders”, lenders who focus on the security and fire market and the RMR that characterizes it. As Emily Maltby of The Wall Street Journal described in the April 26, 2010 issue, “Business owners who approach specialty lenders have an advantage. The loan officer already knows the revenue potential, financing and cashflow needs of that industry, particularly in the context of the broader economy, and can advise with keen awareness of any snags in the business plan.”

The lender will look at the value of the accounts serving as collateral for the loan knowing that their exit strategy in the event that the dealer cannot repay the loan will be to sell some accounts. The good news is that the buying and selling of RMR gives lenders a certain level of comfort about their ability to recoup their money in the unfortunate scenario of a loan default. But lenders want to avoid these situations, so they also want to see that you have the ability and the plan to repay the loan.

Other People’s Money

What all this amounts to is leveraging other people’s money (OPM) to grow your business. There perhaps may be no more straightforward way to illustrate the benefit of OPM than the case of borrowing money for the acquisition of an RMR-based security or fire alarm company.

Let’s do the math:

  • Purchase $10,000 RMR
  • Purchase Multiple = 30x RMR
  • Purchase Price = $300,000
  • Estimated Profit Margin on the RMR = $7,000
  • Monthly Loan Payment = $6,300 (60-month loan at 10 percent interest)

Clearly, the buyer isn’t benefiting from much net free cash flow while the loan is being paid, but the expenses are being covered and owning the new accounts provides other revenue opportunities like upgrades, add-ons and billable service. The expanded customer base boosts further growth through referrals and greater market presence. If the buyer can generate enough referral business to replace the normal attrition that occurs, the net free cash flow will be significant once the loan is paid off.

This article originally appeared in the August 2013 issue of Security Today.

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