Debt for Growth: A Fair Exchange

Prudence and caution are values at the heart of the security industry. They provide the fundamental rationale for the products and services the industry offers, and they also serve as touchstones for security industry executives as they guide their businesses. Many executives believe that prudence dictates that they avoid leverage, but in circumstances where owners seek growth, incurring a measured amount of debt can be a wise decision.

Debt-free operations can feel comfortable, but they can also be a constraint. Companies that fail to grow sufficiently or offer competitive pricing options in today’s business environment are vulnerable to increased competition from cable and Internet providers on one hand and DIY products on the other. Something as simple as a non-amortizing revolving line of credit gives owners the option of taking advantage of growth opportunities that might otherwise pass them by. Used proactively, security business owners can deploy sensible leverage to fund strategic initiatives that can materially improve their companies’ prospects.

Building the Business Organically

A case in point is organic growth. Purposeful leverage can help security business owners reach new customers and grow their companies in a variety of ways. The most obvious growth path is geographic expansion, which might entail hiring a new sales manager, additional sales personnel and installation technicians. It also might require an investment in marketing – both in print and online. A debt facility can be used to fund these additional sales, marketing and installation costs.

Leverage can also help security companies grow by building their base of customers. Here again, working capital can be crucial in enabling companies to fund the larger upfront costs usually associated with larger customers and meeting their tighter timetables. For example, a Capital One client recently won a large contract to provide alarm systems for a mixed-use, residential/commercial/retail development. It was a big win, but it required them to install equipment based on the contractor’s tight deadlines. A revolver – a secured loan where the funds are drawn and repaid as needed by the borrower – provided the additional working capital that made the successful installation possible.

Another route to organic growth is building technological capabilities, which has the potential to generate additional RMR from existing customers as well as new ones. As we all know, the security industry has been transformed by a seemingly endless stream of new technologies – especially home automation, cloud and video. One way that security companies can potentially differentiate their services is through the sophistication and power of their offerings. A revolver can make this sort of differentiation possible. For instance, a security company offering managed access control could tap its revolver to add video capabilities. Using its debt capital, it could build out prototypes or, more likely, integrate off-the-shelf video systems with its existing platform.

Finally, a credit facility can help security companies increase organic growth by enabling them to adopt a more flexible business model. Every security company finds a happy medium between upfront installation costs and average revenue per user (ARPU), though many would rather subsidize the installation as little as possible. This one-size-fits-all approach, however, may exclude otherwise qualified customers who would prefer a larger upfront discount.

Several of our alarm company customers are using credit facilities to experiment with increased subsidization, which can increase account sales and lead to sustained higher RMR. In essence, they are assessing the consequences of moving from a larger product sale with monitoring on the back end to what is essentially a managed services sale – this is not an either-or decision. One option that they can consider is offering multiple plans, each with a different degree of subsidization and different monthly fees. Here again, sensible leverage can give them the flexibility to reach additional customers.

Facilitating Transfer of Ownership

Many security companies are family-owned businesses, which means that, inevitably, the issue of succession planning arises. Leverage provides a well-defined way for owners to transfer ownership to the next generation, take equity out of the company to support their lifestyle or diversify holdings, and incentivize new owners to grow the business.

As a first step, the owners value the company and determine the percentage of ownership to be transferred. A loan tied to RMR enables the company to return equity to the older generation, and could minimize the tax implications for transferring ownership as a gift or the need for a personal guarantee.

The same principles apply in the case of a minority buy-out, for example, when one partner decides to step down. The other partner may not be ready to sell the entire business but lacks the personal funds to buy out the retiring owner. Here again, a debt facility for the company would enable the partial transfer of ownership.

Financing Acquisitions

Many companies in the security industry are a tight-knit local group. As a result, when owners decide to sell, they usually have a pretty good idea which of their competitors they would like to see take over the business. The same holds true for buyers. They know the local market, and they know which competitor’s business would complement their own. When an opportunity arises, however, they might not have the funds to act. A line of credit tied to RMR can make these tuck-in acquisitions work.

Debt financing can also reduce the risk and uncertainty for companies seeking to enter a completely new geographic market. Rather than try to build a new business from the ground up in an unfamiliar setting – a time-consuming process that inevitably entails trial and error –companies can use a debt facility to purchase an established enterprise with an experienced staff and a stable customer base. Having a knowledgeable lender approve the transaction has the added benefit of providing independent verification of its likelihood to succeed. 

Choosing a Lender

Making an informed selection of a lender will give companies the assurance that they are assuming just the right amount of leverage to meet their goals. A thoughtful, well-researched choice should focus on a lender who has compiled a successful track record, and whose leaders are industry experts. Lenders of this caliber will be able to accurately assess owners’ needs. They will also have the experience and flexibility to structure loans that fit their clients’ financial situations and have the capacity to take on larger deals as necessary.

Look for a lender who can provide other services like letters of credit, corporate cards and treasury management. The availability of these services can streamline and simplify owners’ financial management. In addition, these lenders are more likely to view a line of credit as part of an evolving relationship, rather than a one-off transaction.

Ultimately, the ideal lender is one with the desire to forge long-term partnerships and the expertise to contribute to a security company’s success. Having a partner like this can help security companies determine when sensible leverage is a sound choice and how to deploy it strategically.

John Robuck is Managing Director of the Security Finance lending practice within Capital One Bank's Commercial and Specialty Finance business. To request more info, visit www.securityinfowatch.com/12070948.