Grow Your Money Tree
"We are in the carriage trade," says Henderson, CFO of Henderson Security Group, Cincinnati. "We provide customized service to the end-user, and educate them. It's the feet on the street."
Henderson's goal was to increase residential sales from 25 systems a month to 40 or 50, an objective that he understood would require additional sales and technical personnel. But, how does a small security dealer like Henderson find the resources to realize his ambitions? For him and other dealers, the answer was to partner with a lender who specializes in financing to the security industry.
"I've been looking over the years for a financial partner to help fund either acquisitions, or our residential program," Henderson admits. "It's a very capital-intense industry. It doesn't seem that a lot of conventional financing is done through banks. You have to look at specialized financing."
In the financing arena, subscriber monitoring contracts represent the equity that dealers can leverage to get a needed financial boost - helping them grow to that next level by providing a positive cash flow that's often missing.
"For dealers who want to grow, unless they have sources of liquidity they can tap, it's going to be difficult without selling the accounts or using [them] as collateral," says Paul Sargenti, president and CEO, SAFE and SAFE Financial, San Ramon, Calif. "Growth requires investment and the investment has to be made before the capital required for such an investment can be covered by such a cash flow."
In Henderson's situation, he worked with a financial service that provides several types of financing, including both subscriber account acquisition and loans based on the use of a dealer's recurring monthly revenue (RMR) contracts. (For a list of specialty finance firms, see "Who Offers Funding" on p. 48.)
What worked for Henderson was a bulk sale of accounts, followed by an arrangement to sell some accounts on an ongoing basis.
"We're not going to sell our entire portfolio; some we will retain and build the equity in our company as well. With some of these dealer programs, they require you to sell all your accounts," Henderson says.
Easy Money?Once you've decided that you want to grow greater than your current cash flow allows, there are many considerations. The time between reaching your initial decision to finance and actually getting the cash could draw out over months if you're not prepared.
One of the primary considerations is whether to sell your subscriber accounts or borrow against them. There are advantages and disadvantages with each option - assuming that both options are available to you.
"Generally, if you don't have $50,000 to $100,000 RMR, most of the lenders that are out there today are going to say, 'sorry.'If you wanted to find a lender who would lend you money against 100 accounts, you couldn't find one, but you could probably sell them," says Gregory Spurr, managing director, MCG Capital, Arlington, Va.
In addition to the level of RMR, a lender also will consider a dealer's potential for growth. If both options - a loan and a sale - are available to you, then you will need to further assess which will best serve your needs.
"The advantage to borrowing against the accounts is that [the dealer] retains the ownership of the account and therefore, the annuity that the account has associated with it," Sargenti says. The disadvantage is that the multiple used to determine the value of the account is typically lower than in a sale, he adds.
"To give an example, a dealer of some size may be able to obtain from a 32 to 36 multiple on a sale, but will have difficulty borrowing more than 25 times RMR on a loan."
The advantage to selling your accounts outright - either in bulk or on a regular basis over a specified period - is that you can generally obtain more cash than putting up the same accounts for a loan. "But then [the dealer] will have sold the residual value, or their annuity. Both liquidity options can be used very effectively by a dealer to grow their business," Sargenti adds.
"The primary difference between a loan program and a dealer program is you get more cash up front. So if that is your goal - to get the most possible cash today - then you should sell your accounts," Spurr adds.
Your creation costs also are a determining factor in your decision. If your costs to add a new subscriber are average or on the low side of average, then it may make more sense to retain your contracts and borrow against them, because you will not need as much capital to add new subscribers as would a dealer whose costs are above average. (See "Calculate Your Cost to Create an Account," on the previous page.)
"If more capital is needed, the sale-of-accounts option may be more appropriate, whereas if a dealer's creation cost is in the low to mid-20s, clearly to leverage the accounts in one of the many loan products that's offered makes significantly more sense," Sargenti says.
You Need a Cash StrategyIt all boils down to your goals and strategic plans, the financial experts say. How much capital do you need to accomplish your goals, and how can a loan or sale help you develop your strategy?
"There are cases where it makes sense to sell accounts because of where they're located, or you view them as not strategic anymore," Spurr says.
For example, Henderson's goal is to use the residential side of his business to fund the commercial side. By selling his residential accounts, he can raise capital to "flow back into the business. We're looking to bring on more sales people and more technicians. Down the road I don't want to sell accounts, but this will help with the cash flow," he says.
"I'm not suggesting that it's a bad thing to sell accounts. Sometimes you're better off selling accounts, and that's true for a big dealer, too," Spurr says.
For Bob Gobrecht, the deciding factor was getting his start-up company out of negative cash flow. He chose an account sale, kicking off with one bulk amount, then selling a certain amount of customer contracts each month.
"Anytime you open a box and start up a company, you need cash," says the vice president and general manager of American Guardian of Philadelphia, based in Woodlyn, Pa. "Even if you have investment money for the first year or two, you're still at a negative cash flow."
With the cash infusion his company now has, "obviously you grow at a slower pace, but you do not set yourself in debt," he says.
Tony Steverson's company wasn't in debt, but it was experiencing a tightness in cash flow due to the economy.
"We weren't in debt, but a lot of jobs we were doing, it was taking a long time to get paid," says Steverson, president and CEO of Cyber Systems Inc., Ocean Port, N.J. "It just makes things a little easier to have the cash on hand. Also to expand, to buy some new trucks, which were badly needed."
There are three main areas of concentration before beginning the process of qualifying for a loan or account sale.
First, write a business plan or update your existing plan. You must be able to articulate your goals to potential lenders so they can understand how your cash flow will be used to repay the loan.
Second, clean up your subscriber account base. "You've got to go into your account base and remove all accounts that are not paying you anymore, so when a lender or investor is doing due diligence, they don't have to do that," Spurr says. "It makes the company look sloppy."
Third, prepare financial and operational reports. Lenders are going to take a hard look at your attrition rates.
Through The Eyes of a Lender"A security dealer today has to be a better businessman than the security dealer of yesterday and his customer base has to be more qualified. A dealer with a high attrition rate is going to find it imminently more difficult to be financed than one who grows a little more slowly, but with more qualified customers," Sargenti says.
"Lenders and investors are more selective, in terms of who they provide capital to. There are fewer lenders to the industry, because some banks and other specialty lenders have stopped," Spurr says. "The maximum advance rates that were available a year ago have come down. There are more restrictions and controls on dealers. The spread over prime has gone up, even though the prime rate has gone down. It basically means that if you're looking to raise capital, you have to have your act together."
SIDEBAR: Questions You'll Need to AskShopping for a lender can be demanding. It helps to have a set of basic questions to get you started in evaluating both lenders and loan products:
What kind of multiple can I get?
The answer depends on whether you are willing to sell your subscriber accounts or use them as collateral to borrow against. Generally, a sale brings a higher multiple. It also will depend on the quality of your account base.
"It depends on the quality of the account, ranging from 27 to 32 times MRR," says Greg Westhoff, president of Alarm Capital Alliance. "We look at a credit score above 600. We look for some type of investment from the customer. The more they invest, the better the account. That type of account usually will stick with you longer and pay their bills."
And a potential lender will evaluate you as a risk. What is your historical attrition? How many of your customers pay their bills?
What is the interest rate and how much are the loan fees?
"You can think of interest rate and fees as being a method of pricing risk," says Sargenti. "While there are general parameters within which most lenders operate, an interest rate to that dealer will be very specific to that dealer.
"Interest rates are quoted as prime plus 3Â¿ percent to prime plus 5Â¿ percent - sometimes more, sometimes slightly lower, depending on the size of the credit and the circumstances surrounding the colatteral. Parameters exist mostly in the hypothetical, because each dealer's quote will be very specific to that dealer's terms and conditions."
What kind of hold back is typical?
Some lenders hold back a portion of the facility for a certain time period to cover themselves if an account cancels. Others, such as Alarm Capital Alliance, don't have a hold back, but require that the account be replaced within a specified time period.
How long will it take for me to qualify for a loan?
"It depends on how organized they are. Most dealers are appropriately organized to sell and install alarm systems, and not necessarily organized to meet a potential acquirer or lender's due diligence process. The more organized their financials and customer database are, the more up-to-date their insurance and licensing - all those things that a potential acquirer or lender needs to see in order to understand how well the business is being run - the easier it will be for a dealer to obtain financing," Sargenti says.
How quickly will the cash be available, both after the initial sale or loan, as well as on an ongoing basis?
This varies from lender to lender.
Who provides services such as monitoring, follow-up sales, repair and maintenance?
This is one of the most important answers dealers want to know. They want to ensure that their customers will be well serviced, furthering the potential for add-ons and referrals in the future. "They don't want to lose that identity," Westhoff says. "If you've been in the marketplace for several years, and you've built up identity, why let that go? Even though it's not their [subscriber] base anymore, nobody knows that. They can put some money in the bank and continue to drive the business."