Do Contract Term Lengths Affect Valuations?
Determining if it’s contract terms that bind a subscriber to an alarm company or if it’s something more.
The alarm industry gets a bad rap for long-term contracts, mostly because of negative advertising luring customers to “no contract” monitoring deals.
I suppose that because of DIY and wireless systems, as well as cheaper technology and products, there is less investment in an alarm installation than when all systems were hardwired.
It’s only natural that an alarm dealer is going to prefer and be more comfortable with a longer-term agreement.
Our Standard Form Agreements are five years for residential and 10 years commercial. When valuing alarm accounts, an original term of three or five years would not make a significant, if any, difference.
That is if the prospective purchaser is in the alarm business.
A prospective buyer representing a hedge fund and thinking about an RMR investment may have an entirely different way of valuing your business, taking a business enterprise approach.
Most alarm companies have one of two plans on selling subscriber accounts. Some sell the subscriber contracts as they are signed up, or in bulk on a regular basis to the same buyer. Others sell all subscriber accounts as the fulfillment of their exit strategy from the alarm industry.
The length of term of original contract or the average life of the original contract remaining may be critical for the regular seller of subscriber contracts.
If the buyer is more of a finance company or heavily relies on financing to acquire the accounts on a regular basis there will be rather strict guidelines imposed by finance experts.
They may believe that longer-term contracts or contracts in the infancy of the original term warrant a higher multiple calculation times the RMR.
Another alarm company looking to acquire your accounts may accept accounts with a shorter original term and may not be concerned that contracts rely on and are in renewal term.
I believe the percentage of customer base within original term will affect valuation of the multiple, but probably not by much.
Though a customer in original term does have the contract binding them to the alarm company, one that is in renewal and has been so for years may be considered more reliable with a higher likelihood to remain years after that contract is purchased by the buyer.
Keep in mind what the buyer of alarm contracts has to consider. In order to recover investment on the purchase of the contract, there needs to be an expectation of retention of that customer.
Since multiples can range in the high end from 40x-50x the RMR, the retention period needs to be from four or more years, depending on the multiple and the cost of providing the ongoing service.
It could take six or more years to break even on the sale, and since the “guarantee” from the seller is not likely to be more than one year, the buyer is at risk.
The real question is, do you really think it’s the contract term that binds the subscriber to the alarm company?
I don’t; not in the long run. In fact, if you’re running a nationwide operation it may not even be possible to engage in collection litigation.
Customer defaults, end of story; move on. The glue that binds the customer to you is the service. It better be good or your competitor will end up with the customer, contract or no contract.
Good or better service is achieved by customer contact, upgrades, keeping up with and offering new technology and, of course, responsive service.
Technology is the great game-changer. With something new and better you better be offering it because your customers are hearing about it daily from your competitors.
Even if you are one of the nationwide operations with thousands of accounts, you need to be in touch with your subscribers. Regular emails offering new promotions and components will retain your subscribers.
Sell and forget them and your competitors will be offering them someone better and cheaper.
Automatic renewal period becomes less important when you consider the above. It’s not the renewal term that retains the customer. I do not believe that your contracts are more, or less, valuable because you have a one-year or more automatic renewal period. I think month to month is sufficient, especially if you have the original term in the Standard Form Agreements of five and 10 years for residential and commercial, respectively.
If you enjoyed this article and want to receive more valuable industry content like this, click here to sign up for our FREE digital newsletters!
Security Is Our Business, Too
For professionals who recommend, buy and install all types of electronic security equipment, a free subscription to Security Sales & Integration is like having a consultant on call. You’ll find an ideal balance of technology and business coverage, with installation tips and techniques for products and updates on how to add sales to your bottom line.
A free subscription to the #1 resource for the residential and commercial security industry will prove to be invaluable. Subscribe today!