FOLLOW UP TO LENGTH OF TERM OF CONTRACT AND AUTO RENEWAL FROM JULY 21, 2016
Excellent question and answer by your old friend Anon in the July 21st 2016 blog about the effect of auto renewal length on valuation.
In addition to brokering security companies, my firm also performs numerous valuations for owners experiencing divorces, partner disputes, probate issues, etc... so I am usaually asked to value account bases in which the majority of the monitoring agreements are in their auto renewal period.
Valuations are based on cash flow. When I am valuing an account base I am looking into the future and projecting the net cash flow from the RMR. I look at various factors, but I am primarily looking at attrition. Lower attrition = higher valuation. You quoted Barry Epstein and his answer was on point. The length of the auto renew period (and the fact that the customer is out of its initial term) is not a factor… up to a point. I refer to customers who have passed their original term and have automatically renewed a few times as "seasoned" customers. They have had numerous chances to cancel and have remained with the Company. You are correct in that they have most probably stayed with the company based upon service and satisfaction, not because they are contractually bound. I even consider multi-year auto renewals to be a possible issue. I have seen several Bills limiting auto renewasls introduced in State Legislatures and most of them began when a Representative got involved in a constituant's fight against a cell phone carrier or alarm company with an aggregious automatic renewal clause.
When I see an account base with an average customer age of five years or more, and a one year auto renewal, I believe that the majority of the customers are staying with the Company and that they are not likely to cancel based on the contract anniversary. I may even value these companies higher than a company with the majority of its customer base in a multi year initial term or renewal. In this case I would wonder why the other company sees a need to lock customers in for such a long term, and why there isn't a large percentage of happy, evergreen, customers.
I do respectfully disagree with month-to-month auto renewals. If they are necessary to comply with law, a company may have no solution other than have a month-to month agreement, or to send out new agreements each year. If month-to-month renewals are not required, I believe that they present an issue. If a customer that is past its intial term wants to cancel, there is not much that an alarm company can economically do. If an unethical competitor targets a company with one year auto renewals, the targeted company may be able to take action against the competitor. If the targeted company's customers are all in month-to-month autorenewals, the competitor could claim that the customers had a right to cancel at any time.
Smother your customers with attention and service and you will increase the value of your account base. Remember, however, that well written, unmodified, and fully executed, monitoring agreements are important for several reasons, not just for value.
Reitman Consulting Group
Great article on Contracts on July 21 2016. Our company is at the point now where we ask seller clients up front, do you have Kirschenbaum Contracts. If so, they've passed one big test as to whether the Contracts are sellable and legal. We then can concentrate on other areas of our clients business such as attrition, accounts receivables aging, financials etc.
Davis Mergers and Acquisitions Group, Inc.
847 550 1557
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