Not All Contracts are Created Equal

By Scott Bushkie – CBI, M&A Advisor

Scott Bushkie - Cornerstone Business Services

What’s the value of a customer when it’s time to sell your business? The short answer: It depends.

It depends on the length of your relationship, their percentage of your overall sales, and the contractual nature of the relationship. Contracts typically represent more value than handshake deals, but different contracts carry different weight.

One common contract gives the customer a 30-day or 60-day out clause, even if you’ve faithfully delivered on your commitments. Those contracts do have some value, as they probably establish pricing and terms, but buyers typically don’t see a long term commitment from the customer because of the short “opt-out” clause.

I also see annual, auto-renew contracts that can only be cancelled at the end of each year (or on breach of contract). These have a little more value, particularly if you can time a sale near the beginning of your contractual period.

Even better, of course, are contracts with longer term commitments. We’re currently representing a client in year two of a valuable five-year contract. That will provide a buyer with significant time to transition relationships and prove they can continue to deliver the same quality service.

One key factor that significantly impacts the value of any contract, however, is whether or not it is assignable.

I was working with a client out west who had 20-plus leases granting him land rights to mine gravel. His contracts did not have an assignability clause, so we encouraged him to go back out and get amendments to his leases.

The client put it off, assuring us he had great relationships with the land owners and reassignment of the leases wouldn’t be a problem. In truth, once we had a buyer at the table, only a few of the smaller gravel pits signed the new clause while his key contract holders held out for higher royalties. Eventually the deal tanked.

When we took on a second client in the same line of business, we again pushed the owner to update his contracts. This time, the owner did actively secure assignability for nearly all his leases. The buyers noted this early on and told us they wouldn’t have pursued a deal without it. Buyers invest a lot into acquiring a company, and most don’t want to waste their time without assurances your essential contracts will transfer in the sale.

Don’t put yourself in a position of negotiating assignability at time of sale. It eliminates confidentiality and opens the door for customers to hijack your deal. Knowing your company is for sale – and that the sale is dependent on their contract – shrewd customers will ask for lower prices or more favorable terms, knowing you’ll likely agree to anything reasonable. You and your buyer both lose.

Not all industries lend themselves to contracts. Secure them if you can and work with your attorney so you can transition those agreements to a new owner…without asking customer permission first.

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A thought-leader in the industry, Scott developed the Cornerstone Process to offer investment banking M&A-level services to the lower middle market. The result is a closing ratio that’s more than double the national average.