Still more on desperate seller / Final Day ISC Schedule April 11, 2019
KEN KIRSCHENBAUM, ESQ
ALARM - SECURITY INDUSTRY LEGAL EMAIL NEWSLETTER / THE ALARM EXCHANGE
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Still more on desperate seller / Final Day ISC Schedule
April 11, 2019
Notice: See you at Rapid Response booth at 11 am and the J Krug booth at 2:30.
Still more on desperate seller
Many of you commented on the desperate seller’s predicament. You should know, yes, it was a real letter [I don’t make up questions] though the seller is not quite desperate enough to give away the accounts at rock bottom price. This seller’s “terms” for the sale are interesting because bargaining strength is a significant factor when the terms of the Asset Purchase Agreement [APA] is being negotiated. Sellers with little bargaining power will be at the mercy of the buyer who will dictate not only the multiple, but more importantly, other essential terms of the APA.
Ask yourself, what good is a multiple of 40 times if the APA terminology eliminates 20% or more of the account base? What good is a high multiple if the buyer demands indemnity for the seller that puts the seller at risk of giving back almost the entire purchase price? The answer is obvious, it makes no sense.
How do you avoid being in this less than enviable position when selling; having no bargaining power? Well, you have accounts that are described the way the desperate seller describes its accounts:
* old contracts [at least he has Kirschenbaum TM Standard Form Agreements]
* no owned central station lines [accounts on co-mingled with other alarm dealer accounts on central station owned lines]
* No guarantee and no holdback on sale
* No time for due diligence
Believe me there are other issues. You put yourself in strong position by having up to date contracts, cohesive account base, customers current in payment, monitoring RMR, service and inspection RMR, history of running your company following all the “rules” and, maybe most important, engaging counsel who can effectively represent you in a sale transaction so you’re not taken advantage of. Making it through the closing may be the least of your concerns if you’ve left yourself open to liability post-closing.
Re the desperate seller
Let me see. where did i put the keys to my turnip truck......
I should also add that the fact that this dealer (and any dealer) uses your contract certainly helps make the loan approval process go more smoothly.
Responding to Anxious Seller’s email of April 4, 2019. The Seller is “desperate to sell accounts.” This Seller is not only desperate, he/she is delusional. I suspect that this “Seller” doesn’t actually exist and that you are pointing out a range of factors that impede a sale. If that is the case you have detailed quite a bit of valid issues and pointed out some areas for any Seller to address long before they are ready to sell. Anxious will be lucky to attract a Buyer at all because, it is not an attractive deal under any circumstances, and the Seller has added quite a few restrictions that make it even more unattractive. You are correct that the final multiple will be reduced by these factors but I think that some of the restrictions will be different and that there are other factors to consider.
I am going to look at this “portfolio” as if I were valuing it for a divorce or partner dispute. The result would be the same as if it sold, but it will show how experienced Buyers approach this type of transaction.
First we need to set a base multiple and add or subtract based upon numerous factors that affect the value.
• The primary consideration is that a Buyer isn’t buying accounts for accounts’ sake. The Buyer is buying cash flow. The Buyer intends to earn cash from the accounts over a number of years. These future cash flows have value and the Buyer is willing to pay a reasonable price for the cash flows. Nearly all of the considerations center around their effect on the future cash flows. Anxious doesn’t tell us the gross RMR per account and what is typically included but this is a major factor in determining cash flow. For example, a group of accounts generating $32.95 per account with basic monitoring is more valuable than a group of accounts generating $19.95 per account. Let’s assume that the Buyer’s central station and billing cost per account is $4.00 (you notice that in a sale I consider the Buyer’s cost and not the Seller’s cost because the accounts will eventually migrate to the Buyer’s station so the Seller’s cost is not very relevant). This means that the $32.95 account generates $28.95 of cash flow per account per month while the $19.95 account generates $15.95 or a bit more than half. This determines the base value.
• The next factor is to determine the expected attrition. Again we are determining future cash flow, so if the accounts that generate the cash flow are falling off at a high rate, the cash flow will be less, and the value of the accounts will be less.
• The next factor is contracts. Anxious uses Kirschenbaum Contracts. This is a huge plus. Any contract is good, but a well written contract is better. In nearly 25 years of buying and selling accounts I have never seen a Kirschenbaum Contract present an issue (with the one exception in which the Seller ‘stole’ a Kirschenbaum Contract from his friend and forgot to change the venue so that he had Arizona contracts with Florida for the law and venue) so that is a plus. When a Seller does not have good contracts we recommend that they re-contract (typically with a Kirschenbaum Contract) before the sale. We perform this service (mail out a new contract with a cover letter) for $35 an account. If the account base has to be re contracted I would subtract a cost of $50 per account as the process is going to take time and some customers will require more effort than just mailing out new agreements.
• Before we get too excited about Anxious’ great contracts let’s consider that Anxious hasn’t updated the contracts in “8 or 10 years.” This may be OK, but the customers may be in areas in which the auto renewal laws, other other laws regarding the contracts, have changed. This could make the contract invalid. This would require attorney review and could affect a material portion of the contract base, or none at all. My suggestion is to spend the money to update your contracts. You’re not using window foil and old alarm panels so why not upgrade your contracts?
• Anxious wants an ‘all cash deal.’ While it is reasonable to want to get paid in cash, the Seller is indicating that there will be no holdback. This will result in a reduction of more than 10% as the Buyer has no coverage for accounts that cancel in the transition. Sellers who are willing to guaranty the accounts through a holdback period get better prices. Some transactions allow for a ‘base attrition’ rate of 5-10% before holdback but Buyers just adjust the price down to cover themselves for this. Best to stand behind the accounts and negotiate terms into the agreement that the Seller isn’t responsible for accounts lost due to fault of the Buyer.
* Closing the sale in 30 – 60 days is fairly unrealistic. This isn’t a value issue as much as it indicates that the seller isn’t just anxious, but desperate. It is possible to make this time frame but there will most probably be issues (missing agreements, liens, central station issues, etc…) that delay the sale. Anxious is communicating to Buyers that something needs to happen quickly and that he is so focused on selling that he is willing to drop his price if issues threaten to delay the Close. On the other hand, he may be communicating that a Buyer may spend hours and money doing due diligence only to find that Anxious terminates the LOI because they couldn’t make his unrealistic closing date.
• The short time frame may indicate that Anxious faces a major disruption, such as an impending claim, foreclosure, or enforcement action that is going to cause an issue before or after the close. I have a hard time believing that Anxious has spent 8 – 10 years developing these accounts and has to sell them in 30 days, and that it is for a good reason.
• Anxious is going to stay in business. Is there a chance that he may go after the accounts? Transactions go bad all of the time and Sellers may believe that they have been harmed and ‘take back’ the customers. This comes back to my point above, if Anxious doesn’t pay taxes or is being sued over a breached agreement, what makes you think that Anxious is going to abide by the provisions of your Purchase Agreement?
• The accounts are monitored by a ‘National Central Station’ and they are on ‘their phone numbers.’ We would assume that this means that Anxious does not own the numbers, they are mixed with Anxious’ other accounts, and may be commingled with accounts of other companies. They will have to be moved off of that line and to the Buyer’s line. Are the panels downloadable, are they enabled? Anxious should point another line to its existing central and start re programming the accounts in question so that they can be moved at Close. Most Buyers are not going to want to do this, and, if they are, would probably charge $250 or more per account to re program.
• Anxious isn’t ‘turning over any phone lines.’ This may surprise Anxious but, even if the Buyer sends fantastic Welcome Letters yard signs and stickers and clearly communicates how to cancel an alarm, customers are going to continue to call Anxious’ phone number to cancel alarms and for billing questions. How does Anxious want to handle these? How many customers call Anxious’ office number for service and how many call Anxious or a tech for service calls? Is there a chance that a customer would call a tech’s cell phone directly for service and not get a response? I have seen situations such as these result in numerous cancellations.
• Anxious wants the multiple on gross RMR and doesn’t want a reduction for monitoring or pass through. While it is typical not to reduce RMR for basic monitoring (the Buyer knows its cost and includes it in their net cash computation) pass through are different. A Buyer will typically reduce RMR by the cost of pass through because they vary and it is hard to determine the margins from these. Few Buyers will pay for pass through RMR but they may be willing to negotiate the reduction. If Anxious doesn’t want a reduction for this, the Buyer will probably just reduce the overall multiple.
• All accounts have parts and service included. This is known as Embedded Service. This is a cost to the Buyer and reduces the cash flow. It may also place a strain on the service department as some customers will call constantly and expect that the alarm company to repair even damaged parts. How many systems are wireless and is the Buyer going to have to replace batteries? The Buyer is going to want to determine the cost of this and reduce the multiple accordingly.
• Some accounts are CCTV systems. Does this mean that they are monitored video or leased installs. Monitored video is more complicated and costs more to monitor. When a central station receives a burg signal, the operator makes verification calls and cancels or dispatches. The operator can then move on to another call. If an operator observes activity on a video event, he/she has to stay involved in the event and this may take 20 – 30 minutes. This costs money. If the RMR isn’t sufficient to cover this the cash flow will be negatively impacted. If the CCTV systems are leases there are additional issues… is it a lease or an installment sale, does the customer own the equipment, does it include service, does it address technology issues, what is the term remaining on the lease? These accounts could be very valuable or worthless. The Buyer needs to do its homework.
• Most accounts have 2 – 4 years left on the original contract. How long was the original contract? If the original contract was for 5 years the customers may be waiting out the agreement fully intending to cancel. Anxious doesn’t say what the renewal terms are. A five year contract with a five year renewal may be legal but may also be very hard to collect on if the customer decides to cancel during the renewal period.
• Other factors include the location, geographic compactness, type of customer, etc… Anxious wants to pick the accounts being sold. This typically means that the Seller isn’t offering its best accounts. Fire and commercial accounts are generally worth more than mass market residential accounts. An account base in a major metropolitan area is more attractive than an account base in northern Montana. There are more buyers in a major metro area so multiples tend to run higher. Geographic compactness also affects service costs. If the accounts are spread over a 120 mile range they are more expensive to service. Since Anxious gives away service this would create additional costs and no revenue.
Anxious should change their name to Desperate because this transaction won’t price well and probably won’t go well. It is barely big enough to attract most buyers even without all of the conditions and restrictions. If Anxious just needs short term cash the best solution may be a loan against the accounts. There are a few, honest and ethical lenders that would loan a multiple against the account base and give Anxious the needed cash, but allow him to use the RMR to pay off the loan and keep the accounts. They are all found on the Alarm Exchange. Anxious should consider going this route to resolve it’s immediate problem and, if the eventual goal is to sell, start preparing now. This would allow anxious to be the “calm seller.”
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