When buying a business it is imperative to have a strong understanding of the customer base of the business to ensure as a business buyer, you understand all risk factors. In this article, we explain two of the key factors that in our opinion you must look out for when buying a business in order to gauge the risks inherent in the subject business’ customer base.
Spread of Revenue
Businesses that have a small number of clients that make up a large portion of that business’ revenue are riskier than those with an even spread of clients who all make similar contributions to revenue.
Those businesses who rely heavily on one or a couple of large customers to provide most of their annual revenue suffer the risk that (i) those major clients may (and often will) demand that due to their high annual spend with the business that their fees or prices should be reduced which means that the business’ performance will decline and indicates that the business itself may have a decreased level of control over its pricing which is problematic, and (ii) should one or more major clients take their business elsewhere the business will suffer a significant and sudden decline in revenue which may threaten its ongoing viability as a commercial enterprise.
During the due diligence process of buying a business it is very important to understand what the spread of revenue is among clients, especially larger clients to understand how reliant the subject business may be on its major customers.
Payment Terms and Debtors
Businesses that have extended payment terms with all (or some) of their customers will require more working capital which is a risk. Further, payment terms that overtly favour a customer can be rather risky. Some examples we have seen include payment terms that allow customers to indefinitely hold off making any payments during periods of pricing disputes and even clauses that allow a customer to seek refunds well after the date of the provision of goods or services with no explanations required from the customer to do so.
It is imperative that during the due diligence process key customer contracts are reviewed in detail and that disclosures are provided by management at the subject business regarding any verbal agreements or otherwise that are in existence which provide for a change in day-to-day practices to what the terms are of written contracts. Odd looking payment terms and arrangements uncovered as part of this investigation may constitute major risk factors that may impact on the price or terms of your offer to acquire the subject business.
Finally, it’s very important to look closely at the business’ debtor’s ledger. The debtor’s ledger will provide an indication of who owes the business money, and how far overdue they are in their payments.
Looking at a debtor’s ledger can uncover interesting pieces of information. For example, you may discover that a previously large customer of the business has a large overdue debtors balance, with minimal new invoices issued – this may indicate that there may be problems with retaining that customer into the future. Or, you may see that although the business’ standard payment terms for a certain customer (call them Customer X) are 30 days, Customer X consistently pays their bills 60 days after they have been rendered – this may change your view of the working capital required to operate the business and may mean you need to adjust the terms of your offer.
Find Out More
Customer due diligence is an imperative part of the business acquisition process. It’s an area we’re very familiar with, hence if you require any assistance for an acquisition that you are undertaking feel free to contact us for a free confidential consultation with one of our team.