How to Build Company Equity Beyond a Recurring Revenue Model
In his Alarm Exchange newsletter, Ken Kirschenbaum addresses a reader’s question if certain types of recurring revenue enhance the company’s residual value.
GARDEN CITY, N.Y. — If you had to name one incontrovertible truth about the alarm contracting business it surely would be that recurring monthly revenue (RMR) is the lifeblood of any organization. Beyond creating predictable revenue streams, RMR makes businesses more appealing to buyers.
There is fundamentally more interest in installing security contractor businesses that can demonstrate reliable revenue streams. In many cases, recurring revenue can significantly increase the value and sale price of the business.
In a recent installment of his Alarm Exchange newsletter, industry attorney Ken Kirschenbaum addressed the topic of building equity after being prompted by a newsletter subscriber who sought explanation on how to value certain recurring revenue not outlined in an RMR-type agreement.
The subscriber explained as an integrator they offer a wide variety of services beyond the basic monitoring or monitoring + services contract. The revenue stream brought in from a simple contract is typically many times in excess of the base contract, the subscriber expressed. System and code upgrades, tenant improvements, emergency service, add-ons, etc., is where the bulk of the revenue will come from.
Thus, the subscriber asked, how then is this additional revenue valued? Does it add any residual value to the company? “If I am doing $100K per month in gross revenue with only 10% of it in RMR, is the company still only worth a +/- 35x multiple based on RMR? Would it not be better for the long-term picture to roll as much revenue as I can into an RMR-type contract in order to build my long-term equity?” the subscriber posed to Kirschenbaum, who pens SSI’s “Legal Briefing” column.
Kirschenbaum answered, stating the anonymous subscriber was on the right track when observing the typical model for the alarm business is RMR valuation. Kirschenbaum emphasized a caveat: Remember that RMR means RMR under proper contract and really ends up meaning “qualified RMR” or “acceptable RMR” that meets a multitude of criteria defined in each transaction. Be sure you are going to market with updated contracts, Kirschenbaum stressed.
Following is the remainder of Kirschenbaum’s response to the subscriber:
The multiple certainly varies depending on the subscriber base and many other factors, but the constant is the RMR that your company has on its books and hopefully backed up by properly written contracts.
The RMR valuation method will not of course fit every situation. However, many companies who think they deserve to be evaluated differently than strictly a multiple of the RMR may not realize that the few characteristics of their company that may make it unique will be accounted for by adjusting the multiple used to value the RMR.
Having said that, there are also circumstances where there are other reasons to use a different evaluation approach than multiple times RMR. Your company may be uniquely positioned so that significant revenue is derived through non-RMR avenues. A company specializing in fire alarm installations that makes nice profits on the installations, assuming that book of business can be sold with the business, would be entitled to consideration on valuation.
[An earnings before interest, taxes and amortization (EBITA)] calculation could be used and the bottom line is what a buyer could expect to generate and profit from the acquisition. If you have $1.8 million in sales and you can figure out your profit, if there is one, then there would be a value assigned.
Alarm companies — now life-safety integrators and sometimes home entertainment companies — may not be limited to the lease, monitoring and service RMR model, but that is still the traditional way to value an alarm company.
So when I get inquiries explaining that there are other aspects to the business that should be valued, that’s fine, but those evaluations are different than the RMR evaluation.
Finally, to answer your last question, yes. In the alarm industry the RMR model is still by far the business structure and the most familiar way to value the equity and sell the business assets. Be sure to engage competent counsel.
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