Welcome to The Business Academy. Today I'm doing a deal breakdown for you so you can see how I think about when investing in a small business..
🔑 An interesting deal
Here's a breakdown of an interesting business I found. It's a security service company (link at the bottom of this article)
I'm a fan of the security service category. The more comprehensive your service offering, the higher your margins, and the stickier your product.
There is a wide range of security companies out there.
On one end of the spectrum, you have the folks who are glorified admins. You know these security guards, they sit at a desk and they act as a deterrent for criminals. But they cannot get involved if there is an ongoing crime.
On the other end of the spectrum, you have security teams that can serve as backup to city police departments. These are highly trained ex-military people. For example, I recently did a training class with Covered 6. One of their clients is the city of Beverly Hills where they provide fast response to emergency calls, and fly surveillance drones to deter theft.
In my opinion, if you have the option, you want your company to be specialized. It's going to be more effort, but it's also going to offer better margins, long-term contracts...etc
However, I would not dismiss a regular security company outright. The trends are in your favor. Cities are struggling with their police departments. Crime is up. This means stores and cities need more security.
The listing mentions the security industry is poised to grow 6% per year. This needs to be validated (I would get a report from IBIS). If this is true, the industry is growing very fast. The current market size for security surveillance is $48 Billion. That means it's adding $2 Bn of value per year. That's a lot of space to fill with your little security company.
The company has experienced good growth over the last five years (30% per year).
Revenue 2022 $3.4MRevenue 2023 $4Madjusted EBITDA 2022 $1.07M (SDE)adjusted EBITDA 2023 $1.4M (SDE)It's based in Denver, Colorado. Denver is a growing city (1.8% per year).
So you have a growth business, in a growing industry, in a growth city. Those are all good indicators.
Concerns / Considerations
Leadership - You'll need to price in a General Manager into this business before you determine the valuation. I would say for a business this size, between base compensation and performance you're paying $175k to $275k. They say the business has strong leadership, but you must validate this. You need someone to run the company unless you plan to run it yourself.
People Heavy - Security businesses are people businesses. The people will make or break your company. You need to be prepared to build extensive protocols and training, and if you're running this business, you'll be losing sleep when people don't show up for the job or they fall asleep in your top client's office. During diligence, meet the people and interview them to understand what makes the people in this company unique.
Sales Post Acquisition - Often in these B2B service companies, the owner does 100% of the sales. You need to be careful because after you buy the business, sales may drop off a cliff. Some of the big customers may be country club or childhood friends of the owner. They won't have the same allegiance for you as the owner. And you'll need to figure out who does the sales post close.
Price Competition - My high school friend's father owned a security company. The business did incredibly well. He would bring in Ukrainian and Russian immigrants to come work for him at minimum wage which helped his margin. Given this is likely unskilled labor (to be confirmed) you may be competing with security companies that undercut you on price because they can hire undocumented labor. As you're doing your diligence you need to understand what makes this company stand out and how they win contracts. If they're winning on price, that's not a game you want to play.
Customers & Contracts - ideally you're looking for multi-month, or multi-year contracts with your customers. Understand the customer profiles, review every contract, and speak to a handful of the customers. Your goal is to understand why do people use this company over others. What happens if this company raises prices by 20%, will it lose most of its customers?
When I'm entering a new industry I go through a research checklist. This allows me to get to know any new industry:
1. Talk to owners of security companies
2. Talk to other private equity investors who specialize in this industry (after a quick search I found this)
3. Talk to investment bankers who sell private equity firms (here is the first one I found)
4. Attend an industry-specific tradeshow (ask the bankers and PE for the best show to attend)
5. Sign-up for trade magazines or newsletters, and join a forum or facebook group
6. Hire an advisor who has bought and sold security companiesYour goal through this research process is to understand the following questions:
"what makes a security company less or more valuable?"
"what are some things to look out for in diligence, or common mistakes people make?"
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🔑 One good read
This is an excellent story from 2003 about Martin Franklin who started as a corporate raider and then went on to build one of the most wonderful holding companies ($12 Billion+ in market cap). Over the years he bought many household brands like Ball Jars, Sharpie...etc
Have a great week!
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👉 💰 💰 💰 💰 💰 Top-notch!
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Disclaimer: nothing here is investment advice. Please do your own research. The information above is just for information and learning.