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The Value of Customer Contracts When Selling a Business
If you are a small business owner, it is important to understand that buyers are very interested what the company has earned in terms of profit but also (more importantly) what the company is expected to earn in the future. The main reason why historical earnings are relevant when selling a business is to be used as a proxy for the future. One important way that buyers can examine the future viability of the company is by examining its contracts with customers. This article examines how a properly crafted contract can demonstrate sales and profit stability in a business and also increase the price it sells for.
All other things being equal, a contractual relationship with your clients should translate to better deal terms when you sell. Some high level variables to look for in a customer contract:
In many industries, customer agreements can make or break the value of the business. Consider the example of a commercial cleaning business for sale. If there were no customer agreements in place, the value would be more questionable. This industry is very competitive and characterized by low cost wages and new entrants who are more than willing to undercut the incumbent in order to win the customer over. A formal agreement in this scenario would insulate the company from these types of peaks and valleys.
Banks like it too
Financing a business purchase in Canada can be a very difficult undertaking so showing the institution that they would be financing a venture with a predictable cash flow gives them a better sense of risk management. Banks hate risk so anything a seller of a small business can do to mitigate them will only strengthen a loan application.
Can they be transferred?
If you are a buyer, you should obviously have a commercial lawyer review and contracts or company agreements before you buy a business. Some additional things a lawyer will review is how transferable the agreements are in a sale of the business. In some instances, they need to be assigned to the new owner and that may require the consent of all parties to the contract. This is not always the most elegant of solutions. In some other cases, no action may be required and the contracts may be simply transferred with a sale of shares. Again consult with your lawyer on this point.
All other things being equal, a contractual relationship with your clients should translate to better deal terms when you sell. Some high level variables to look for in a customer contract:
- How long is the term of the contract?
- What is the escape clause? If there is one, are there any penalties associated with it?
- How is competition handled. Can they, or you, deal with competitors?
- What is the method for conflict resolution?
- Does the contract auto-renew or is a new signature required at every expiry?
- If it does auto-renew, are there built-in increases in rates, quantities.
- What are the service levels agreed upon?
In many industries, customer agreements can make or break the value of the business. Consider the example of a commercial cleaning business for sale. If there were no customer agreements in place, the value would be more questionable. This industry is very competitive and characterized by low cost wages and new entrants who are more than willing to undercut the incumbent in order to win the customer over. A formal agreement in this scenario would insulate the company from these types of peaks and valleys.
Banks like it too
Financing a business purchase in Canada can be a very difficult undertaking so showing the institution that they would be financing a venture with a predictable cash flow gives them a better sense of risk management. Banks hate risk so anything a seller of a small business can do to mitigate them will only strengthen a loan application.
Can they be transferred?
If you are a buyer, you should obviously have a commercial lawyer review and contracts or company agreements before you buy a business. Some additional things a lawyer will review is how transferable the agreements are in a sale of the business. In some instances, they need to be assigned to the new owner and that may require the consent of all parties to the contract. This is not always the most elegant of solutions. In some other cases, no action may be required and the contracts may be simply transferred with a sale of shares. Again consult with your lawyer on this point.