With overall mergers and acquisitions (M&A) activity on the uptick, the security industry’s use of M&A as a tool for growth is poised to jump in 2015. Last year, the overall value of M&A transactions climbed 47 percent worldwide and 55 percent in North America, according to Investor’s Business Daily. Ernst & Young reported that favorable deal-making conditions in 2014 have carried over into 2015.
Although 2014 was not a particularly robust year for M&A in the security industry, we are seeing early signs that conditions are changing that are not only good for internal growth, but also for growth through M&A. We believe mid-tier deals will increase significantly in 2015 due to several factors, including continued support from the capital markets, the lending community and institutional investors. In addition, business valuations have remained stable and have attracted major, sophisticated investment houses. Finally, the entry of more private equity groups has bolstered the buyer’s market for mid-sized security companies, as they add to their platforms.
The increased availability of capital is a key driver for M&A activity because it allows security companies to leverage their assets, including recurring monthly revenue (RMR), for funds without sacrificing equity or bringing on other partners. In addition, these funds can be used for general purposes, working capital and organic growth, in addition to acquisitions.
Here are some key considerations for using debt to spark growth through M&A activities:
What types of companies should be considering M&A to grow?
Companies looking to make an acquisition should have a base business strong enough to take on the acquisition process and merge operations effectively. Financial and internal controls should be robust.
For example, if a company has $200,000 in eligible RMR and $1 million in outstanding debt, an RMR structure could offer up to $4 million more in financing proceeds that could be used for tuck-in acquisitions. Moreover, an acquirer could aggregate the amount of RMR between the acquiring company and the target, and then borrow on a multiple of that amount. For companies in this position, this is an efficient form of financing that is shaping the way acquisitions are being performed in today’s market.
How does an acquisition fit with an organic growth strategy?
Acquisitions can augment and diversify a company’s customer base and can be used to establish a beachhead in a new market. As opposed to building new offerings or entering new geographies from scratch, an acquisition can be a more efficient way to quickly obtain scale in new areas.
Acquisitions also can leverage operations and infrastructure to efficiently expand concentration and increase RMR in existing markets by increasing the density of a customer base. Two companies that have been slugging it out in marketing can eliminate the competitive situation by merging. As new types of services are delivered, such as video monitoring and home automation, the average amount paid per-customer is increasing. Thanks to these new services, security has become a high-touch industry with greater customer service demands. A concentration of customers in one geographic region can allow for better, quicker service calls.
Finally, an acquiring company can bring new energy to a target company that may have atrophied, by adding scale and resources to increase sales in existing territories. We have seen the benefits of this acquisition strategy time and time again across our portfolio of clients. In one particular instance, our client adopted this plan to supplement organic growth, improve account density, and expand into new markets. Capital One Bank provided a $20 million line of credit with a full suite of banking services to support their objectives. Since the initial closing of the facility two-and-a-half years ago, this client has closed seven transactions and has entered three new markets. The facility was utilized to fuel this growth and is now $30 million. As a result, the company’s RMR increased by 45 percent.
What should you look for in a financing partner?
When searching for a financing partner, companies should look for someone who truly knows the security industry and all of its nuances. An experienced lender with expertise in the industry’s trends, challenges and opportunities can help in the due diligence process, and bring in the right advisors so that the transaction is priced and structured correctly.
The lender should also be able to grow with the borrower over time and have the capacity to commit future capital that is part of one facility. A long-term relationship can be a significant benefit as the lender can learn the strategy and changing needs of the borrower and bring additional financial offerings to the table.
Finally, the lender should have a track record of executing transactions and living up to its commitments. It is important to do research to make sure your lender has experience, but also the flexibility and responsiveness to address unique requirements that may exist. With the right lender and financing strategy in place, an acquisition can lead to new customers, new capabilities and long-term growth.