If you are considering selling your company, remember that contracts and agreements are critical elements that can enhance your company’s value. Strong multiyear contracts with customers create revenue certainty and enhance profits. Similarly, vendor contracts that lock in the prices of your raw materials will ensure you are able to maintain production at profitable levels and meet customer demand. The certainty that comes with locking in multiple agreements enhances the value of your business.
Customer contracts are not always easy to establish, but they are a great value enhancer. With such a contract, you create revenue certainty that allows your company to plan and grow. Some buyers place a high degree of importance on these contracts, while others might view them as optimal but not critical. So, even if a lack of contracts doesn’t decrease your chances for a sale, it might decrease your company’s value.
A key element to consider regarding customer contracts is whether you can assign them to a buyer. Many contracts are not assignable because the customer established them to ensure they continue doing business with the people they signed up with. This means you will need to approach your customers who have contracts that don’t allow for assignment and ask them to assign the contract to the buyer. While doing so might be uncomfortable, it’s necessary to guarantee the buyer gets the company it paid for. Normally, you won’t go down this path until you feel confident that the deal will close.
The type of business you have will determine how likely you are to have contracts with suppliers. In certain segments, such as distribution, contracts can play a critical role in the growth of your business. In others, contracts are less important but still valuable. Locking in your supply of raw goods or other products as well as your costs for those goods can foster growth and profits. If your company uses products whose prices can be somewhat volatile (e.g., copper or precious metals), ensuring a ready supply and stable pricing can be critical. With price volatility comes the need for caution, since changes in raw goods prices may impact the price you charge and your profit margins. If the materials you use are prone to price fluctuations, evaluate hedging strategies to lock in prices and secure some certainty in your costs.
One pitfall to avoid is supplier concentration. When more than 10% of your purchases come from one vendor, there is a risk that your operations could be damaged if this company were to stop selling to you. Even if such a scenario seems unlikely, the risk can impact your company’s value. Buyers want to make sure you have certainty and diversity in your supplier network. Work to diversify your vendors, and make sure you have backup suppliers for all critical materials.
Supplier agreements, like customer contracts, may have clauses that prevent you from assigning them to buyers. If yours do, you will need to go through the same process as with customers, which, depending on the type of business you have, may be easier than reassigning customer contracts.
There are many ways to enhance the value of your business, but one of the best is to have contracts and agreements in place with your customers and suppliers. Buyers will covet the certainty of revenue and costs, which will foster growth and profits. Having such contracts in place will increase your purchase price multiple and lead to a greater payday when you sell. If your industry typically does not use these types of agreements, don’t worry. Focus on the diversity of your customers and suppliers, which also will enhance your value.
If you have questions about how contracts and agreements can create value at your company, please contact us. We have advised numerous companies on different value drivers and how they will impact companies at the time of sale.
This is the sixth article in our Value Driver series. Click below to explore the other topics.