A couple of days ago we started a series of blog posts that look at common reasons deals either get complicated or take much longer to complete than needed. The issues we’re examining can be easily corrected with strategic planning, hard work, and dedication to addressing the issues.
In the first article we looked at the problems buyers often have with excessive owner dependence and provided guidance on how you can overcome this concern. As a reminder, we are not implying that if your company has any of these issues that your business is not sale-able or attractive to buyers. With enough of the right intangible assets, your company could be very valuable to a variety of buyers. However, what we are telling you is that if you want an OPTIMAL deal with a PREMIUM buyer, addressing these common issues can be very helpful to you and your transaction.
What does “customer concentration” mean? To different buyers it means a variety of things. In general, if a significant percentage of a business’s revenue is generated by a limited number of clients, buyers may have some concerns. Secondarily, if these key revenue streams are largely dependent on the current owner’s relationships with the clients, buyers may have trepidation about this as well. So let’s look at both of these items.
First, the definition of “significant” will vary depending on the type of buyer you are interested in attracting. For example, if your industry is comprised of a limited number of potential clients and you are trying to close a deal with a strategic player in the same industry who understands the nuances, it may not be a major factor at all. Having said that, if more than 20% of your revenue comes from a single client, even industry buyers will have some concerns.
Likewise, if your buyer is outside the industry, perhaps a synergistic strategic player or an equity firm creating a platform, dependence on a limited number of clients could be considered a risk factor.
This does not mean that these types of buyers will walk away from your opportunity. What it usually means is that due diligence (the research that buyers do to ensure that what they are acquiring meets their standards and expectations) may take longer and require more reps and warranties on your part; and that the ultimate deal structure may include an earn-out period so that they can ensure that the client base remains loyal under new ownership.
In addition, and this harkens back to our first post in this series, if you as the owner also “own” the relationships with these key clients, buyers may have heightened concerns not only about concentration of revenue but also about the longevity of the accounts upon your departure. Again, this will not necessarily kill your deal, but it will prolong due diligence as buyers will likely want to have pre-deal close conversations with all key customers to determine if your exit will impact business.
Again, a common way to get around this issue is an earn-out of 2-3 years. However, keep in mind that this structure usually commits you to staying with the company in some capacity, often as CEO, for that timeframe and ensuring the revenue/earnings targets are met. Certainly there is tremendous upside to this structure assuming the company exceeds the earn-out parameters. Conversely, should it not, targets may be missed reducing your ultimate payout, and under the new ownership you may not have as much authority to affect change and make decisions as you have now.
Enter the market and discussions with buyers after conducting a full business review. You and your sales staff may have grown far too complacent the last few years. Certainly the recovery from the Great Recession has caused many business owners to accept business and write contracts with entities that they may have turned down when times were better.
It is important to analyze your customer mix every six months anyway, whether you are going to market or not. If you find that a few key clients are now generating more revenue than you expected, it might be a good idea to create an incentive plan to encourage your sales staff to aggressively pursue other business.
The good news is that this can be accomplished while still marketing your business – they are not mutually exclusive, i.e., you don’t have to wait until everything in your client base is “cleaned up.” In fact, buyers will be impressed if you and your sales team are actively pursuing other business and that you have strategies in place to effectively do so. Buyers appreciate that businesses are addressing issues, planning, and participating in strategic business development.
If you would like to learn more about how buyers approach companies and what they look for, attending a Generational Equity M&A seminar would be of benefit to you. We hold these complimentary, no-obligation meetings throughout North America and the U.K., and they are designed to enable business owners just like you discover how and when to effectively exit your company.
Carl Doerksen is the Director of Corporate Development at Generational Equity.
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