Why alarm companies must be financially solvent
- By Jim Wooster
- Aug 01, 2013
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
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.