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How Will CA's New Auto-Renewal Law Affect Multiples On A Sale - December 20, 2016

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HOW WILL CA'S NEW AUTO-RENEWAL LAW AFFECT MULTIPLES ON A SALE
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Ken,
    I’m sure this is more of a acquisitions question then a legal one but hopefully someone will have an answer. With the upcoming law change in California disallowing automatic renewals of more than month to month after the initial term, how will this affect multiples when it comes to valuation of a company? I know other states have had this law on the books for a long time.
Mark S.
California
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RESPONSE
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    California's automatic renewal law goes into effect January 1, 2017.  You can see the law here:
https://www.kirschenbaumesq.com/article/sec-73-section-759954-of-the-business-and-professions-code-effective-january-1-2017-
    Automatic renewal laws are not unique to California and have been around for long time in other jurisdictions.  To check your state go to: https://www.kirschenbaumesq.com/page/alarm-law-issues and check the auto renewal statutes state by state.  [if we missed any let us know]. 
    As far as I know all of the automatic renewal statutes share a common exception, no prohibition for month to month renewal.  That is why the Standard Form Agreements all have month to month renewal.  If you have more than month to month, and you don't comply with the automatic renewal statute, your contract will be unenforceable.  How that plays out in litigation is an issue, one that you don't want to wait until the end of a case to find out.  So from a collection perspective you won't be able to enforce the contract to collect for the balance of the renewal period; you may not be able to recover past due money either; you may have to refund any money collected in the renewal period.   
    But of far more consequence, what if you can't use the contract to defend yourself from a subscriber claim for a loss.  That lawsuit is going to be for much more than your monitoring charges, maybe exceed your insurance coverage and might even exceed the value of your alarm business.  
    And then the question, what about value of the contract. the equity it brings to the table when you are negotiating a multiple to sell the alarm contracts and accounts?
    The answer is not that easy because there are variables that affect the overall valuation.  Typically in an Asset Purchase Transaction [or Stock Purchase] there will be a single multiple.  It's a blended multiple that takes into consideration the makeup of the accounts.  Certainly there are transactions that have several categories of accounts with different multiples and conditions of sale, and that would be the likely scenario if there are large amounts in each category.  For example. you have 2000 monitoring accounts and 1000 repair service RMR accounts.  May as well calculate the multiple differently.  But if you have 2000 monitoring accounts and 300 repair service accounts, you will likely see a blended single multiple.  That multiple will take into consideration the 300 repair service RMR accounts, which have a lower valuation for the RMR multiple.
    This same analysis is applied to accounts that are in original term and those in renewal term.  If you have 2000 accounts in original term and 300 in renewal term, more likely to get a single blended multiple.  But if half the accounts are in renewal don't be surprised if you have two multiples to negotiate.  This would be especially so if you have not complied with automatic renewal laws.
    To answer the question directly, generally contracts in automatic renewal are viewed the same way as contracts in original term; priced close if not the same.  But, if most contracts are in renewal, as opposed to most being in original term, then there may be a lower value, but not by much unless the seller has ignored the applicable automatic renewal law, in which case it may be hard to find a buyer willing to offer more than 15 times.  If you're wondering why even offer 15 times?  Because the buyer will shake out the trouble accounts, compel all subscribers to sign new contracts, reduce the purchase price by hitting the Hold Back, and end up with an account base under new contracts.  That's the plan.
    When dealing with a single blended multiple a seller may not be fully aware of how the buyer arrived at the offering multiple.  There is a reason that multiples can range from less than 15 to more than 50.  It's the quality of the account.  Quality of account may also be somewhat subjective.  Is it over-priced so you make more money than average?  Does the subscriber have a great payment record and low service request history?  Is it intrusion or legally mandated fire alarm system?  Is subscriber a tenant or property owner?  Is the system sold or leased?  All important criteria.  But guess what the single most significant OBJECTIVE criteria is going to be?  You guessed it, the Contract.  And if you're not using the Standard For Agreement in its most updated version you're not going to maximize the multiple.  That's just the way it is. 
    From the buyer's perspective, if the contracts are not updated Standard Form Agreements [they will have the KIRSCHENBAUM TM and copyright], the buyer isn't getting the best value and the best protection available by contract.  If you don't think so then just ask an alarm company owner who is involved in a subscriber claim lawsuit.  
     Next week we will announce the availability of our updated 2017 forms, and we will offer a short window for a "sale price".  Think about updating your contracts now and be prepared to order next week to take advantage of the discounts.  [if you need your contracts now then better order now to avoid the 2 to 4 week wait once the sale is announced]
      I asked Steve Rubin to comment on the question.  Here is his response:
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Ken
    It shouldn't affect the multiples at all.  It hasn't in the States where this is law now.  Most buyers look at the payment history of each subscriber.  If it indicates prompt payments for a long period of time, and you have a Contract with all the proper legalities such as Kirschenbaum's, most buyers will not lower their offers.  Many alarm companies, where this law is already in effect, send out new 3-5 year Contracts when the end of the initial term is six months away.  This way they always have Contracts with initial terms.  It's a lot of work but well worth the effort, more for you than the buyers.  These dealers usually send a letter along with the Contract stating that nothing changes and this will keep their monitoring fees the same for the next year.
    For more information on items to know when considering a sale, Ron Davis has written the definitive Book called "The Start of the Deal".  It's packed with information all companies should know whether considering selling in the next year or decade.  The Book is FREE.  Just email us at rdavis@graybeardsrus.com with your Company name, name and title, address, phone and email address.  We'll send the Book right out and, by the way, we would appreciate your critique.  Just one idea from Ron's Book could dramatically help the direction of your business.       


Steve Rubin
Davis Mergers and Acquisitions Group, Inc.
847 550 1557
srubin@graybeardsrus.com
www.graybeardsrus.com
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