When you are selling your business, you should be prepared for the different types of deal structures that may be proposed from various buyers. A business sale often consists of multiple elements like cash at close, seller notes, non-competes, books and records adequate enough for business financing by lending institutions, allocation of assets, capital gains, etc. 

More often than not, a first-time seller will actually put out his or her hand in a stop gesture and reply, “I only want the full price in cash at close.” 

This article will discuss some of the selling company characteristics that directly affect both the selling price and the terms.

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Important Variables That Determine The Buyer’s Offer to Purchase A Business

Selling Company Revenue Composition

This is a very important factor in determining how much a buyer will pay for your business and how much will be in cash at closing. If 80% of your annual revenue is a result of contractually recurring revenue, you can command both a premium price and a deal heavily weighted in cash at close.

On the other hand, if you have little or no contractually recurring revenue and are heavily dependent on net new sales from new clients, your sale price will be far less. 

Companies that can demonstrate historically repeatable revenue with long-term clients will fall between the two extremes mentioned above.

Selling Company Management Depth

If every aspect of the company’s business funnels through the two key partners who are close to retirement age and there is a huge gap in management depth and capabilities, this is risky to buyers. They are not inclined to write a big check to the owners only to have them walk out the door with their relationships and knowledge six months later. 

The more decentralized the customer and supplier relationships are and the more widely dispersed the intellectual property is, the higher the sale price and the higher the percentage of transaction value is at close. 

If it is all concentrated, the buyer will want the insurance of a transaction structure that pays over time based on future company performance.

Selling Company Customer Concentration

You can absolutely correlate purchase price and cash at close to this element. 

Let’s say, for discussion purposes, that you had two identical companies in revenues, profits, profit margins, and EBITDA. Company A has no more than 5% of their revenue coming from a single customer. Company B has 40% of its revenues coming from four large blue chip accounts. 

Company A will sell for a 15-25% premium to Company B. Also, Company B will command only 60 to 70% of the cash at close that Company A commands. 

Customer concentration is a big risk factor for a buyer that cannot assume that the relationship dynamics will be the same once the principals leave.

Main Street versus B2B Company

Typically the issue of seller notes comes up with an individual buyer that has limited resources and is attempting to buy a main street type business with as much leverage as possible. Corporate buyers seldom utilize this vehicle.

Professional Services Type Firm

Your company literally walks out the front door each evening. 

These may be consulting firms, accounting firms, executive recruiting firms, ad agencies, etc. Your producers have developed their book of business and their loyal account relationships. Your clients are customers of the company, but may be more loyal customers of their professional contact person. 

Sales transactions for this type of firm can involve a very heavy earn-out component to protect the buyer from a mass exodus of clients because the professionals leave the firm post-acquisition and take their clients with them.

Non-Compete Agreements

These are pretty much standard for prudent buyers buying a company and not wanting to defend themselves against the former owner who gets bored with retirement and decides to start a similar business. 

The seller should get some compensation for the agreement, and the more restrictive the agreement, the higher the compensation.

Stock Sale versus Asset Sale

Most large corporations “have a policy” that they will only do asset acquisitions as opposed to buying the stock of a target company. There are some very good reasons to do this. When you do a stock purchase you get all the assets and all the liabilities, both known and unknown. 

If you look at the reasons buyers have escrow accounts, many of the same reasons apply for wanting to do an asset acquisition. They simply are buying identified assets, and the remaining corporate shell is still owned by the previous owner with all the liabilities not specifically identified in the asset purchase agreement.

If the seller is a C-Corp, however, it is a major negative from a tax perspective to do an asset sale, because the sale of assets is taxed as ordinary income at the corporate tax rate. The proceeds are taxed again at the owner’s long-term capital gain rate when the funds are distributed to him. 

For companies that do not have the escrow-type potential liabilities, a stock sale may work. A buyer could successfully offer a significantly lower price with a stock purchase than a competitor requiring an asset purchase. The seller should analyze the two transactions from an after-tax proceeds perspective to determine the superior offer.

If you are a business owner contemplating a business sale and you want the highest purchase price and the most cash at close, analyze your company based on the factors above. If you can implement changes that correct some of these risk factors, you improve your odds of your best exit.

Of all the risk factors buyers weigh when pricing an offer, few carry as much weight as who, exactly, is generating the revenue. A concentrated customer base signals fragility, while a diverse one signals resilience, and that distinction alone can move both the price and the structure of a deal. Let’s take a closer look at customer diversity as a standalone value driver, and why buyers scrutinize it so closely.

Business Value Driver #3: Customer Diversity

When selling your business, it is important to know that your customer base has a major impact on its value in the marketplace. A diverse customer base means your revenue comes from a number of clients or customers, not just two or three, and preferably comes from multiple sources other than your primary service.

Simply put, the more customers contributing to your sales revenue without a few dominating that figure, the more valuable your business will be.

Why? 

Because it reduces the risk of serious cash flow issues if one or more customers do not stay under new ownership.

As with all value drivers, it is all about risk. Just as the proverbial “too many eggs in one basket” strategy is risky, so is a small concentration of customers dominating your revenue.

Potential buyers look for a broad customer base in which no single client accounts for more than 10 percent of total sales. 

An enterprise serving a multiplicity of customer types, or customers in unrelated industries that are not affected by the same economic conditions, further mitigates risk. Customer diversity measures how insulated your business is to any large-scale domino effect from a reduction in demand or economic problems your customers may face.

Here are a few things to understand about your customer base and of interest to potential buyers:

• A quick insight into the diversity of your customer base is to run a “gross-revenue-by-customer-report-by-year.” It will show you the percentage of total revenue each of your customers generates year by year.
• Customer databases contain valuable information that a potential buyer can use as a source of competitive advantage. It has potential to generate future earnings for a new owner and may add significant value.
• What industry sectors do you serve?
• What geographical area do you serve?  Are your customers mostly local, regional, international?
• Pay attention to your accounts receivable and aging report, because this will indicate if your customers are facing cash flow issues.

Customer Concentration: “Too Many Eggs in One Basket” Scenario

Just as a business enjoys value drivers, it may also suffer from value detractors, one of which is customer concentration. Many small businesses have customer concentration issues, which must be addressed in order to sell the business.

Buyers are typically concerned when an individual customer accounts for more than 10 to 20 percent of the overall revenue. It is important to appreciate this concern from the perspective of a potential buyer. 

This insight can help identify creative deal structures that mitigate the risk in a manner acceptable to both the buyer and seller. The goal is to demonstrate that, while the risk factor exists, the likelihood of losing a key customer is remote.

Common concerns and questions include:

•       What would be the impact from the loss of a major customer?
•       Is there a customer contract in place? Is it transferable?
•       Is there an exclusivity relationship with the customer?
•       Is the longevity of the relationship of significance with the customer?
•       Does the customer have more than one location serviced by the company or purchase multiple products? If so, this signifies that there is a co-dependency and solid relationship with this customer.
•       Does the customer enjoy preferential pricing that would be hard to find elsewhere? Is it a high-volume, low-margin customer? If so, the profitability of this customer’s loss may not seriously impact the company’s bottom line.
•       How painless is it for the customer to switch to a competitor, and what could cause that to happen?
•       Is there a relationship with the current owner and the customer such that the continuity of the customer under new ownership may be uncertain?
•       What can be done to reduce this percentage of concentration?

A buyer’s concern in this area may result in a lower sales price or a deal structure that would bridge the risk gap. For example, a certain portion of the purchase price is held in escrow in the event one or more customers are lost post-closing, during a defined period of time, usually a year or less.

Another possibility would be earn-out payments over time based on company performance. Of course, these deal structures place some of the risk back on the seller, which is not ideal for the seller.

But the fact is that customer concentration is a serious issue and cannot be avoided. Retention of major customers through a transition period will be a predominant concern of any buyer. With proper presentation, and by potentially structuring a transaction that will mitigate some of this transactional risk, the better the probability of a sale and maintaining a fair purchase price.

Understanding how diversified or concentrated your customer base is naturally raises a follow-up question: how much should you actually disclose about those customers, and when? Protecting the detailed makeup of your customer list during a sale process is its own value-preservation strategy.

Protecting Your Customer List While Selling Your Business

Your customer base is the foundation of your company. Knowing who they are is crucial to your business, which is why potential buyers will want to know as much as possible about your customers.

Therefore, if you are thinking about selling your business, be ready to provide a basic profile of your customer base. However, caution should be taken to protect this valuable asset. Do not share detailed information about your customer list with any prospective buyer until the buyer has taken possession.

So, you might wonder, how then do you provide customer information to potential buyers who are interested in the potential acquisition of your business? 

One method we have used is to compile a list of all customers and name them using letters, numbers, industry types, or a combination thereof to identify them. Next to each referenced customer is the sales revenue generated from that customer for a specified year or series of years.

It does not have to be complicated. It would be a good idea to put a list together before you start the sale process. It will have an impact on valuation.

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Having assisted thousands of business owners in successfully selling their companies, we have built a reputation grounded in consistent, measurable results over more than four decades. When you work with us, you’ll experience firsthand how our reliable leadership translates into a smoother, more informed transaction.  We encourage you to contact us to learn more.