10 Ways to Future-Proof Your Business

Dorsie Mosher and Steve Rubin of Davis Mergers & Acquisisions Group,
Security Sales & Integration, February, 2012

Given the worldwide economic woes, safeguarding against whatever trials and tribulations the future holds for your business is a welcome concept.Future-proofing involves a strategic plan that ensures your business is positioned today to meet the challenges of tomorrow.

Future-proofing involves recognition that business environments are constantly changing, frequently due to external factors, and you need to implement the right strategies now to ensure your business will continue to thrive in the years ahead. While there are numerous strategies that can be employed to hedge against future challenges within the alarm industry, this article presents 10 critical components to help you future-proof your business.

1. Diversification

The stability of your business is strengthened as you diversify the types of customers and the types of services you offer. This does not mean you attempt to be all things to all people. It does mean you do not focus on builder sales (residential or commercial) to the exclusion of other sources of revenue.

Looking at your customer mix, in most cases a good split between residential and commercial systems will serve you well as the future unfolds.

Where it comes to service offerings, include a broad spectrum of the security industry (intrusion, fire, access, video, etc.). Doing so greatly enhances your opportunities for continued growth and profitability.

2. Accurate Bookkeeping

Keep good records and books. It is virtually impossible to make sensible management decisions if you don't have the ability to accurately evaluate the profitability of the various sectors of your business. Proper accounting principles are the key to this.

The basic foundation for useable accounting information is the segregation of revenue by product and/or service with the segregation of expenses by product and/or service. This detail will provide you with the input you need to make decisions regarding expanding or reducing the various sectors of your business.

3. Mind Your Compliance

Proper contracts are critical to future-proofing your business. Not only do contracts provide critical limitation of liability to you and to your business in the event of loss of life and/or property where you have provided the alarm system, but they are the dominant value of your company in the event you need to borrow money or decide to sell.

In addition to mitigating the day-to-day risks of being in business in the security industry, proper insurance that is uninterrupted throughout the term of your business is necessary to maintaining top value for your company. At a bare minimum, you need these types: errors and omissions; general liability; vehicle; property; and workers comp.

Proper licenses for each of the product and service offerings you bring to market are also an absolute must.

4. RMR Mindset for Every Sale

Many companies are willing to accept just the profit from the installation of an access or video installation. Well-managed companies try to extract a recurring monthly revenue (RMR) component by offering service contracts on every sale. While service contracts are never as profitable as monitoring contracts (and consequently sell for a smaller multiple), they are a great stabilizer of company revenue. Rightfully so as they add substantial value to a company.

When the concepts of "predictable cost" and "technology refresh" are included in the sales presentation for products like access control and video surveillance, a high percentage of end users will opt for a service contract. The service contract positions the installing company to keep the competition out and create a new sale prior to the end of the contract. The copier industry has perfected this strategy. How many times have you ever gotten to the end of your copier contract before the vendor was there selling you new feature-benefits?

5. Build Up Your Infrastructure

While it may make you feel good to be the "decision maker" at every level in your company, it's a risky approach. If your company needs you 24/7 to keep things organized, you don't have many choices for an exit strategy or a succession plan. Build the team.

Many buyers look for an "absentee ownership" situation because it is a good indicator that the company can do as well after an acquisition as they did before even though the owner is no longer there. In contrast, a company whose owner has all of the customer relationships, holds all of the licenses, and manages all of the sales, operations and administration of the business does not have a bright future when the owner leaves. That is unless the new owner has a management team that can be brought to bear. Consequently, there are significantly fewer buyers for owner-dominated companies.

6. Benefit From Legal Status

Which legal business designation is best for you: S corporation, C corporation, limited liability company (LLC) or sole proprietorship? All of them have tax ramifications. Although there may be benefits in being a C corp. while operating your company, when selling it is a definite burden.

S and C corp. status is exactly the same with respect to liability protection. The difference is how you are taxed. The C corp. has what is referred to as double taxation. First the corporation itself is taxed on the profits it makes. Then when these profits are distributed to the shareholders as a dividend, they report it as income on their individual tax returns. So essentially you are paying taxes twice on the same money your corporation makes.

As an alternative, an S corp. is a tax election a C corp. can make in order to eliminate the corporate tax level. This allows the earnings to pass through the corporation to the shareholders. You only pay once on the earnings. This is a great tax advantage, especially when selling, possibly cutting the taxes on a corporation's profits in half. Talk with your accountant and attorney to ensure you qualify to elect to be taxed as an S corp.

A C corp. wishing to switch to an S status should, again, talk with an accountant and attorney. While it can be a viable change, there is a required five-year waiting period for it to become effective. C corps. are definitely sellable; however, the buyer must be willing to buy the stock of the corporation. This means taking on the seller's liabilities, which, in turn, usually results in a lower priced offer than if it were a S corp.

An LLC is treated the same as an S corp. but with more flexibility. The downside is that the LLC is more costly to set up and maintain. The filing and annual fees are greater than an S corp. Another disadvantage is that a sole owner of an LLC is taxed as if they are self-employed (sole proprietor). That is usually not the best tax position for a business owner. Again, consult your accountant and attorney for the best advice.

7. Retain Monitored Accounts

If you're not big enough to profitably operate your own central station, you may not want to start one. There's a tremendous cost in building and maintaining it properly. Yes, it will give you a sense of satisfaction that if you control it, it will be done right. However, at what cost? Research this thoroughly before jumping in as it could literally drain you.

If you are using a third-party central station, make sure you own the phone lines so you control the accounts. If for whatever reason you need to move those accounts (bad service, selling your company, better pricing), if you own the lines it's very easy to do. It may cost more per month, but then you, not your central station, own the lifeblood of your business - your customers. If the central station owns the lines, it controls your customers. And for those who have done this in the past, you know that reprogramming the accounts is a nightmare.

If you are using a third-party central station, be very careful about the terms of your contract with the provider. Try to avoid a "Right of First Refusal" term because it will impede your ability to move quickly if you decide to sell your accounts and/or your company. Buyers are hesitant to expend the time and money to gather enough information to make an official offer if the central station has the opportunity to simply match the buyer's offer in order to make the purchase. Yet the third-party provider does not have to make an offer until another offer exists.

A second precaution regarding third-party centrals is not to get into a contract that has a long initial term (e.g. three years) and automatic renewals for the same term. These typically have a 60-day advance notice to terminate requirement. If you decide to sell your company shortly after this deadline passes, you are faced with three years of monitoring fees even though you have sold the accounts and they are being monitored elsewhere.

8. Financial Management

Pay close attention to your financials. Your business is all about fiscal responsibility. Produce good financial statements monthly. Read and understand every line item. Everything has a cause and effect, and should be clearly illustrated in these statements. Adjustments never have to be drastic as long as you conduct monthly internal audits.

The buyers, when they conduct their due diligence on your company, will pore over your financials. After all, they're about to pay you hundreds of thousands, possibly millions of dollars for your company. They and their bank have to be comfortable that you have been fiscally responsible. Incidentally, raising monitoring rates periodically without overpricing (5% or so every two years) creates more value with some buyers.

9. Watch Attrition

Pay attention to your attrition. Why is it happening? The average attrition rate in our industry is about 6-7% per year for smaller companies. If you had 100 customers at the beginning of a year and 93 of those same customers at the end of that year, that's a 7% gross attrition.

We've all heard it's more costly when you lose an existing customer as opposed to adding a new one. Service is the key. If the service goes down, attrition goes up. This becomes a real warning flag for a potential buyer. High attrition means an unstable customer base.

10. Keep Up With Market Trends

Take time to study market trends. You're directing your people through myriad changes. To stay ahead of your competition, you have to be on top of current trends. Whether it's economy related, political, city or state regulation changes, product innovations, competition or industry happenings, it's better to be ahead of the curve than trying to catch up.

Future-proofing is about mitigating or eliminating the impact future events may have on your business. Following the principles outlined in this article can help you make sure your company will prosper in spite of future trials and tribulations.

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Dorsie Mosher is former Principal, and Steve Rubin is a Principal at Davis Mergers and Acquisition Group.