This article originally appeared in the September 2022 issue of Security Business magazine. When sharing, don’t forget to mention Security Business magazine on LinkedIn and @SecBusinessMag on Twitter.
In the life safety industry, it is nothing short of astonishing that by the time a popular ranking of the top 100 electronic security companies for 2021 was published, seven of those companies had already been sold. The four buyers of those seven companies represented very distinct parts of the life safety ecosystem.
There are vast amounts of private equity money coming into all parts of the life safety sector at the moment, and these companies are looking to buy integration, fire and alarm companies.
For integration companies, it is an extremely active market. In past years, when we took a deal to market there would be three or four buyers who we knew we wanted to talk to. Now, we talk to nine or ten every time, because these buyers want to expand rapidly into different markets and in different segments of the industry.
As one buyer told me, we are seeing once-in-a-generation valuations, which is very good for the industry. The buyers really are coming from everywhere.
The Buyers
If you are ready to sell, your first imperative is to know where to find direct buyers. Normally, business owners who are ready to sell their companies go to competitors or buyers they find via their industry association. Today, sellers have many more choices, including:
Integrators who are not owned by private equity – These are strategics in the industry. They are companies you probably compete with. They are often limited as to what they can pay in a multi-buyer process since they do not have the deep pockets provided by private equity backing.
Integration companies owned by private equity – These are often platforms that were originally bought with the goal of growing both organically and through acquisition, in order for the private equity firm to flip it in 5-7 years.
Fire companies – These buyers were not as active in the integration market three or four years ago. Their buying has picked up dramatically as these companies gain a wider range of services by acquiring a security integrator.
Adjacent industries – Other industries that are buying integration companies include guard companies and door companies. The opportunity to cross-sell has a huge upside for these buyers.
Private equity companies not in the sector – They call themselves industry agnostic because they focus more on revenue growth and profitability than on what industry the seller is in. If the buyer can see strong growth in both size and profitability in 5-7 years, they are interested.
Alarm industry buyers – This group tends to want integrators with meaningful recurring revenue. The buyer wants a lot of managed services, and is concerned about the perceived risk of installation revenue falling and having overpaid for a smaller amount of EBITDA.
Do you Need Sell-Side Representation?
The easy answer is no – you can sell your company on your own without a sell-side representative; however, you are going to leave a lot on the table. Those who use sell-side representation usually go through an auction process, which means attracting multiple buyers from different geographies and different markets that a seller would be highly unlikely to find.
You spend all your time running a company; sell-side representatives spend all their time selling companies to buyers. They take the emotion out of a deal and enable the buyer to ask hard – and sometimes perceived as insulting – questions about the company it wants to acquire. They are better suited to negotiate with the buyers as they have likely engaged with them on several previous transactions.
Elements of the CIM (or the Book or the Deck)
Once you decide on representation and you have narrowed the list of buyers, it is time to put together information about your company. This is usually called the Confidential Information Memorandum (CIM) or “the book”; however, the younger generation and venture capitalist side call it “the slide deck.”
There are several key elements of a CIM (outlined below); however, prior to sending the CIM to the buyers a non-disclosure agreement (NDA) must be signed to ensure that anyone who gets a glimpse into the inner workings of your company will not share the information.
Within the CIM, buyers want to see the history of the company’s profit and growth. A great story sells a company much better than you might think – buyers buy what they feel comfortable with; they are buying your company culture. They want to see how you go to market, what markets you specialize in, how you are doing from a growth and financial perspective, etc. Other elements include:
• Business generation – Some businesses run on autopilot, and they work on referral; others go direct or through a general contractor. Is the majority of your business bid or negotiated?
• Sales – Most businesses have commissioned sales teams, but some do very well with in-house, non-commissioned sales. All these details matter to a buyer.
• Vertical markets and technologies offered – What percentage are your top verticals of total revenue? What vendors do you use and is this complimentary with the buyer?
• Geographic area of service – Some areas provide more significant growth opportunities than others. This matters more to private equity, which is hyper-focused on growth.
• Top 10 customers by percentage – A buyer needs to understand your top customers (without names at first) and the percentage of total revenue that each constitutes.
Adjusted EBITDA: The Math that Sells Your Company
In slow periods – which we are definitely not in now – buyers might try to buy based on a three-year average of adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization, plus addbacks). Every transaction I have been involved in during the past two years has been based on the trailing 12 months, because most integrators are having good or great years.
The market will not allow valuations based on averaging in the COVID years; if you have eight potential buyers and three of them want to average in the COVID years, a seller will simply deal with the five other buyers instead.
So how do you calculate your adjusted EBITDA to reach this magic number that a buyer is going to multiply by to create a purchase price for the company? This is where people leave a lot of money on the table.
EBITDA is net income and adding back the interest, taxes, depreciation and amortization, but that is not the number by which your buyer will multiply; to arrive at adjusted EBITDA, three important items will impact the addback equation:
1. One-time revenues will not count and one-time expenses can be added back – for example, collecting on a lawsuit or a building issue that cost $300K.
2. Personal expenses – I have seen all types of expenses that sellers put through their businesses. If you can prove it is related to the business, the buyer will add these back in since they are presumably expenses that the buyer will not have.
3. Salary adjustments of owners – If the owner is making $400k a year but agrees to continue to work for the company for $200k after the acquisition, the difference can be added back.
Both COVID payments and employee retention credits are not counted in adjusted EBITDA.
The Offers
Multiple offers are great, but getting the right offer is the goal. The first aspect to getting the right offer is anchoring, which is, in essence, setting an expectation of the sales price. There is no need to waste everyone’s time if you will only sell for a certain price and the buyers are coming in far below that number. Some sellers simply ask to see what the buyers will pay without any indication. This often works but usually brings the widest range of buyers.
Occasionally, a buyer will state what minimum is required for a sale. In this fast-moving market, the buyers who come in at the minimum have been left far behind.
The second aspect comes from the buyer, in the form of an Indication of Interest (IOI) and/or a Letter of Intent (LOI). An IOI is an informal proposal to buy in which a buyer makes an offer with a valuation range for the business to see if they are in the ballpark. This range, if acceptable, moves them to the next round of letters of intent.
Many transactions in the life safety sector go straight to the LOI, which is a much more formal and specific way to make an offer on the business. Most LOIs break down an offer into how much they will pay and how it will be paid, which for integrators usually is expressed either as a set price for the company or as some multiple of adjusted EBITDA.
Most LOIs include a freeze period, where the seller agrees that upon signing an LOI it will not shop the company to other buyers for a period of generally 90 days. This is because the buyer is spending money on digging into the details of the seller’s company. The last thing a buyer needs is to get two weeks from closing and the seller says they just received a better offer. When this happens, some buyers will walk away from the deal. You must keep your integrity in order to get these deals done, and it must work on both sides.
The LOI will also specify whether the sale is a stock or an asset purchase, as well as the terms of the purchase price. There are several varieties of purchase terms, and in the end, it may be one or a combination of several of the following:
- Cash at closing;
- Holdbacks tied to items that put the buyer at risk;
- A note to be paid out over a course of time as negotiated;
- An earnout, where the owner receives additional monies if certain targets are reached over specific times; and
- Cash with an equity roll, where an owner gets an up-front payment but does not cash out a percentage of that payment and instead rolls it by getting shares of the buyer’s company. The rolling of part of the purchase price will be paid out after the private equity company sells off the portfolio company at a later date. Equity rolls can result in a strong amplification of the purchase price if the later sale doubles or triples the roll.
Once the LOI is signed, the buyer will initiate its own due diligence – often by paying an outside firm to confirm the numbers that the seller has represented in the financials and other items outlined in the CIM. It is an extensive but very manageable process.
Your selection of an attorney to negotiate the purchase agreement can greatly affect your deal. You should look specifically for a transaction attorney and not your litigator. An industry transaction attorney who will not have to learn about the vernacular specific to our industry is optimal.
Selling your company will be the largest monetization of your career. You have one chance to get it right. Put together your best team and sell into a hot market and you will position yourself to far exceed your goal.
