How Customer Concentration Affects Business Valuation
How Customer Concentration Affects Business Valuation
Customer concentration can be an issue when selling your business if any one client accounts for 15% or more of your company’s revenue. It can be a troubling situation to find yourself in because the fewer clients that contribute to your profitability, the greater the chance of losing a sizeable chunk of your income should one or two customers leave.
If this describes your business, you should be taking steps to expand your customer base – especially if you’re thinking of selling. Generally speaking, the less diversified your revenue stream:
- The higher a risk it represents to potential buyers, and
- The lower your business valuation is likely to be
It may still be possible to reap a higher price for your business, however, if you structure its sale to offset buyer risk.
How?
Let’s say one of your customers represents 30% of your revenue. A buyer may be willing to pay one price for the portion of your business that doesn’t rely on that client – 70%, in this case – and do an earnout for the remaining 30%.
In a typical earnout situation, the seller remains involved with their business for an agreed period of time to help keep a lucrative client onboard. If successful, the buyer pays the seller an additional agreed upon amount. If the customer leaves regardless, the seller may forfeit that fee or a portion of the amount.
The downside of an earnout is that it can prevent a quick exit. So if that’s your eventual goal, you should be working to diversify your customer base to strengthen your valuation down the road.
Read MoreSelling Your Business To A Financial Buyer vs. A Strategic Buyer
Whether you want to sell your business next year or a decade from now, you will have two basic options for an external sale: the financial or the strategic buyer.
The Financial Buyer
The financial buyer is buying the rights to your future profit stream, so the more profitable your business is expected to be, the more your company will be worth to them. Strategies that are key to driving up the value of your business in the eyes of this buyer include de-risking it as much as possible, creating recurring revenue, reducing reliance on one or two big customers, cultivating a team of leaders, etc.
The Strategic Buyer
The alternative is to sell to a strategic buyer. They will care less about your future profit stream and more about what your business is worth in their hands, typically calculating how much more of their product they can sell by owning your business. Strategic buyers are usually big companies, so the value of being able to sell more of their product or service because they own you can be substantial. This often leads strategic buyers to pay more for your business than a financial buyer ever would.
For example, Nick Kellet’s Next Action Technologies created a software application that takes a set of numbers and visually expresses them in a Venn diagram. Next Action Technologies was generating approximately $1.5 million in revenue when they received their first acquisition offer; Kellet’s first valuation was for $1 million, a little less than revenue, which is a pretty typical from a financial buyer.
Kellet knew the business could be worth more to a strategic buyer, so he searched for a company that could profit by embedding his Venn diagram software into their product. Kellet found Business Objects, a business intelligence software company looking to express their data more visually. Business Objects could see how owning Next Action Technologies would enable them to sell a whole lot more of their software, and they went on to acquire Kellet’s business for $8 million, more than five times revenue – an astronomical multiple.
Preparing For Every Eventuality
The question is: why bother making your business attractive to a financial buyer when the strategic buyer typically pays so much more?
The answer is that strategic acquisitions are very rare. Each industry usually only has a handful of strategic acquirers, so your buyer pool is small and subject to a number of variables out of your control; the economy, interest rates, the competitive landscape and a whole raft of other variables can all impact a strategic acquirer’s appetite to buy your business.
Think of it this way: imagine your child is a promising young athlete who’s intent on going pro. You know that becoming a professional athlete is a long shot, fraught with unknown hurdles: injury, the wrong coach, or just not having what it takes to compete at the highest levels. Do you squash her dream? No, but you do make sure she does her homework, so if her dream fades she has her education; you make sure she has a back-up plan.
The same is true of positioning your company for an exit. Sure, you may want to sell your business to a strategic buyer in a spectacular exit, but a financial acquisition is much more likely, and financial buyers are looking for companies that have done their homework – companies that have worked to become reliable cash machines.
Want to see how sellable your business is? Click here to learn more and take a 13 minute Sellability Score survey.
Read MoreWhat Makes Your Company Unique Increasing Value When Selling
There are unique attributes of a company that make it more attractive to a possible acquirer and/or more valuable. Certainly, the numbers are important, but potential buyers will also look beyond them. Factors that make your company special or unique can often not only make the difference in a possible sale or merger, but also can dramatically increase value. Review the following to see if any of them apply to your company and if they are transferable to new ownership.
Brand name or identity
Do any of your products have a well recognizable name? It doesn’t have to be Kleenex or Coke, but a name that might be well known in a specific geographic region, or a name that is identified with a specific product. A product with a unique appearance, taste, or image is also a big plus. For example, Cape Cod Potato Chips have a unique regional identity, and also a distinctive taste. Both factors are big pluses when it comes time to sell.
Dominant market position
A company doesn’t have to be a Fortune 500 firm to have a dominant position in the market place. Being the major player in a niche market is a dominant position. Possible purchasers and acquirers, such as buy-out groups, look to the major players in a particular industry regardless of how small it is.
Customer lists
Newsletters and other publications have, over the years, built mailing lists and subscriber lists that create a unique loyalty base. Just as many personal services have created this base, a number of other factors have contributed to the building of it. The resulting loyalty may allow the company to charge a higher price for its product or service.
Intangible assets
A long and favorable lease (assuming it can be transferred to a new owner) can be a big plus for a retail business. A recognizable franchise name can also be a big plus. Other examples of intangible assets that can create value are: customer lists, proprietary software, an effective advertising program, etc.
Price Advantage
The ability to charge less for similar products is a unique factor. For example, Wal-Mart has built an empire on the ability to provide products at a very low price. Some companies do this by building alliances with designers or manufacturers. In some cases, these alliances develop into partnerships so that a lower price can be offered. Most companies are not in Wal-Mart’s category, but the same relationships can be built to create low costs and subsequent price advantages.
Difficulty of replication
A company that produces a product or service that cannot be easily replicated has an advantage over other firms. We all know that CPA and law firms have unique licensing attributes that prevent just anyone off of the street from creating competition. Some firms have government licensing or agreements that are granted on a very limited basis. Others provide tie-ins that limit others from competing. For example, a coffee company that provides free coffee makers with the use of their coffee.
Proprietary technology
Technology, trade secrets, specialized applications, confidentiality agreements protecting proprietary information – all of these can add up to add value to a company. These factors may not be copyrighted or patented, but if a chain of confidentiality is built – then these items can be unique to the company.
There are certainly other unique factors that give a company a special appeal to a prospective purchaser and, at the same time, increase value. Many business owners have to go beyond the numbers and take an objective look at the factors that make their company unique.
Copyright Business Brokerage Press, Inc.
Read MoreQ3 2015 Sellability Score Tracker Results- How Sellable Is Your Business?
The 3rd quarter 2015 Sellability Tracker showcases survey results based on business’s completing The Sellability Score Survey, an interactive tool offering a comprehensive assessment of the “Sellability” of a business. Completing the Sellability questionnaire gives you an overall Sellability Score out of 100, plus your score on the eight key drivers of Sellability, which are statistically proven to increase the value of your company.
The average offer multiple of earnings for owners completing the survey for Q3 2015 was 3.76. Below are a few Q3 highlights from a few of the 8 key drivers that have an affect on how Sellable a Business is and on Multiples of Earnings from buyer’s offers. How Sellable is your business?
|
Multiple of Earnings |
Q3 2015 Sellability Tracker Average is 3.76 |
| 3.99 | If your business is geographically scalable |
| 4.03 | Companies that offer little or no customization to their product or service get somewhat higher offers. |
|
Owner Relationship with customer |
|
| 2.92
4.52 |
Owner knows each customer by first name
Owner does not know customers personally and rarely gets involved in serving an individual customer. |
|
How Easy Would It Be To Accommodate 5 X Demand? |
|
| 2.94
4.56 |
Impossible
Very easy |
|
Businesses with recurring revenue > than 50% of total revenue get more offers and higher multiples. |
|
| 3.76
4.14 |
12.29% of surveyed received offers (average)
17.56% with recurring revenue > than 50% of revenue received offers |
|
Size matters |
|
| 2.86
3.67 4.42 5.10 |
< than 1m in Revenue
1-3m in Revenue 3-10m in Revenue 10m+ in Revenue |
|
Record Keeping |
|
| 2.37
3.42 4.59 |
Bring shoebox of receipts to CPA at years end
Use accounting software product like QuickBooks Review and Engage accounting audit in place |
|
Overall Sellability Score |
|
| 2.76
3.59 3.76 4.17 5.10 6.27 |
<50
50-60 Average 70-80 60-70 80+ |
The Sellability Score algorithm was developed using a quantitative survey of business owners and is continually refined, based on the thousands of business owners who get their score each quarter. Achieve a Sellability Score of 80+ and – based on research from thousands of test cases – your company will be worth 71% more than the average business. To learn more about how to improve the Value of Your Business visit Evobizsales.com or call Evolution Advisors in the Roseville/Sacramento area at 916-993-543.
Read MoreWhat Makes Up The Value Of A Business?
Many courts and the Internal Revenue Service have defined fair market value as: “The amount at which property would exchange between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts.” You may have to read this several times to get the gist and depth of this definition.
The problem with this definition is that the conditions cited rarely exist in the real world of selling or buying a business. For example, the definition states that the sale of the business cannot be conducted under any duress, and neither the buyer nor the seller can be pushed into the transaction. Such factors as emotion and sentimental value cannot be a part of the sale. Surprisingly, under this definition, no actual sale or purchase has to take place to establish fair market value. That’s probably because one could never take place using the definition.
So what does make up the value of a privately held business? A business consists of tangible and intangible assets. The tangible assets are the most visible and the ones on which buyers too often base a judgment on the value of a business. Factors of value, fixtures, equipment and leasehold improvements are often valued first by the buyer. Well maintained equipment and attractive interior surroundings are the first things a buyer sees when visiting a business for sale. Make no mistake, regardless of what prospective buyers may say, the emotional impact of a physically well-maintained business can be a very positive factor. In addition, it is much easier to finance tangible assets than intangible ones.
However, buyers have to consider what is really behind those well-maintained tangible assets. There are many businesses, especially today, in which physical assets play a very small part in the success of the business. These intangible factors include: the business’ reputation with its customer or client base, and within its industry; mailing lists and customer/client lists; quality of product or service; reputation with its vendors and suppliers; strength of the business’ technology and other systems; plus many other factors that can add a lot more value to the price of the business than can shiny equipment.
Although the intangible assets listed above cannot be seen, they are certainly an important part of the business – and purchase price. Businesses that don’t need expensive fixtures and equipment can, in many cases, be expanded more quickly and inexpensively because they do not require cash-intensive equipment purchases. Buyers, to their own detriment, do not want to pay the same price for equivalent cash flow for businesses that do not have lots of equipment. They want to buy tangible assets.
Business brokers and intermediaries know how to point out to prospective buyers the advantages of businesses that may not require lots of equipment but have those all-important intangible assets that create steady cash flow. Business owners who have a service or other type of business that does not rely on the heavy use of tangible assets and are considering selling, should talk to their professional business broker/intermediary who can point out the pluses and the hidden assets of the business.
© Copyright 2015 Business Brokerage Press, Inc.
Read MoreFinancial Management for the Closely Held Business, presented by Tri Counties Bank
Tri Counties Bank locally in the central valley is presenting four 2-day Business Financial Management seminars in Grass Valley, Sacramento, Chico, and Redding in September and October. Here’s a brief summary and for more information on attending click here.
“Businesses face tough challenges and unique opportunities. The financial success or failure of a business lies in its owner’s ability to manage through the challenges and capitalize on the opportunities. Now you can learn to proactively control the finances of your company through business-tested financial management techniques and maximize profits through more informed decision-making.
This two-day seminar explains in simple, clear language what financial management is and why it can greatly improve your profitability. We guarantee that you will walk away with tangible tools that you can put to use immediately in your own company.”
September 15-16, 2015 Grass Valley
September 29-30th, 2015 Sacramento
October 13-14th, 2015 Chico
October 27-28th, 2015- Redding
To learn more and register on line click here.
Read More
Scale Up Your Service Business to Increase your Business’s Value
Increase the value of your company by training others in your area of expertise.
It can be tough to grow a service business. Clients are typically buying your expertise, and if all you have to sell is time, the size of your business will always be limited by the number of hours in your day.
One way to scale up your service business is to launch a training division to teach others what you know. That’s what Nancy Duarte did when she found herself run ragged trying to grow Duarte, a Mountain View, California-based design studio.
Duarte’s specialty was creating high-impact presentations (her firm created the slides Al Gore used in the movie The Inconvenient Truth), but the work was tough to scale. She found herself spinning various plates and hoping none of them would fall to the ground. Finally she realized she was exhausted and no longer enjoying her job. She still loved the business but hated the constant demands on her time and energy.
In an effort to pull herself out of individual projects, she sat down and documented her methodology and from there created an internal training course so her employees could learn the Duarte way of creating presentations.
Once she had taught her own staff to handle the development of the presentations, she turned her philosophy and her approach into a book that was published in 2008 under the title Slide:ology – The art and science of creating great presentations. Her most recent book, Resonate: Present visual stories that transform audiences, was published in 2010). Having created a platform with the books, Nancy launched her training division, which offers corporate on-site workshops—her facilitators go to large companies to teach the employees how to make better presentations.
Due in large part to the training division, Duarte has scaled up her service business to the point where she now employs 82 people.
As business owners, we all know we should be documenting our systems for others to follow, but somehow writing our owner’s manual always takes a backseat to serving the next customer or fighting the next fire. Maybe what we need to do is stop thinking of writing down our process as an internal chore and instead focus on launching a training division. That way, the job of documenting our system goes from a textbook-boring task to the raw material needed to launch a revenue-generating business division. If your looking for a platform to use in creating your systems, check out this book “Work the System” by Sam Carpenter. Easy read and really helps break down the basics of the process to systemizing your business.
Read More
How Does Your Business Compare?
When considering the value of your company, there are basic value drivers. While it is difficult to place a specific value on them, one can take a look and make a “ballpark” judgment on each. How does your company look?
| Value Driver | Low | Medium | High |
|---|---|---|---|
| Business Type | Little Demand | Some Demand | High Demand |
| Business Growth | Low | Steady | High & Steady |
| Market Share | Small | Steady Growth | Large & Growing |
| Profits | Unsteady | Consistent | Good & Steady |
| Management | Under Staffed | Okay | Above Average |
| Financials | Compiled | Reviewed | Audited |
| Customer Base | Not Steady | Fairly Steady | Wide & Growing |
| Litigation | Some | Occasionally | None in Years |
| Sales | No Growth | Some Growth | Good Growth |
| Industry Trend | Okay | Some Growth | Good Growth |
The possible value drivers are almost endless, but a close look at the ones above should give you some idea of where your business stands. Don’t just compare against businesses in general, but specifically consider the competition.
As part of your overall exit strategy, what can you do to improve your company?
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: kconnors via morgueFile
How Does Your Business Compare?
When considering the value of your company, there are basic value drivers. While it is difficult to place a specific value on them, one can take a look and make a “ballpark” judgment on each. How does your company look?
| Value Driver | Low | Medium | High |
|---|---|---|---|
| Business Type | Little Demand | Some Demand | High Demand |
| Business Growth | Low | Steady | High & Steady |
| Market Share | Small | Steady Growth | Large & Growing |
| Profits | Unsteady | Consistent | Good & Steady |
| Management | Under Staffed | Okay | Above Average |
| Financials | Compiled | Reviewed | Audited |
| Customer Base | Not Steady | Fairly Steady | Wide & Growing |
| Litigation | Some | Occasionally | None in Years |
| Sales | No Growth | Some Growth | Good Growth |
| Industry Trend | Okay | Some Growth | Good Growth |
The possible value drivers are almost endless, but a close look at the ones above should give you some idea of where your business stands. Don’t just compare against businesses in general, but specifically consider the competition.
As part of your overall exit strategy, what can you do to improve your company?
© Copyright 2015 Business Brokerage Press, Inc.
Photo Credit: kconnors via morgueFile
Read MoreValuing A Business: Some Difficult Issue with Business Valutions
Business valuations are almost always difficult and often complex. A valuation is also frequently subject to the judgment of the person conducting it. In addition, the person conducting the valuation must assume that the information furnished to him or her is accurate.
Here are some issues that must be considered when arriving at a value for the business:
Product Diversity – Firms with just a single product or service are subject to a much greater risk than multiproduct firms.
Customer Concentration – Many small companies have just one or two major customers or clients; losing one would be a major issue.
Intangible Assets – Patents, trademarks and copyrights can be important assets, but are very difficult to value.
Critical Supply Sources – If a firm uses just a single supplier to obtain a low-cost competitive edge, that competitive edge is more subject to change; or if the supplier is in a foreign country, the supply is more at risk for delivery interruption.
ESOP Ownership – A company owned by employees, either completely or partially, requires a vote by the employees. This can restrict marketability and, therefore, the value.
Company/Industry Life Cycle – A retail/repair typewriter business is an obvious example, but many consumer product firms fall into this category.
Other issues that can impact the value of a company would include inventory that is dated or not saleable, reliance on short contracts, work-in-progress, and any third-party or franchise approvals necessary to sell the company.
Want to learn about selling your business and what your own personal Sellability Score is? Click here.
If you’re interested in learning about your selling options, getting a professional business valuation, or getting help creating an exit strategy, please feel free to CALL Evolution Advisors at 916.993.5433 or visit our website: www.EvoBizSales.com
© Copyright 2015 Business Brokerage Press, Inc.
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