08 Nov Boosting Business Value with Long-Term Customer Contracts
Some businesses are able to secure long term contracts that ensure continued revenue streams far into the future. If we begin with the business exit in mind, then a potential seller should never underestimate the value of secure, long-term customer contracts. Revenue that is contractually guaranteed to the business as a going concern significantly decreases the business risk. Buyers love when they can accurately predict future earnings long after the seller has flown the coop.
Not only does a stable revenue expectation help bolster value, but it can also help financing professionals better plan for expected business expenses, including fixed and variable costs that may be incurred to produce the expected revenues. It can also be beneficial in predicting expected timing of both costs and revenues as contracts play-out over an expected period. In short, knowing both revenues and costs in advance is great for business planning and ultimately allows for optimized operations, better profitability and a more predictable outcome for a potential company acquirer.
Stable revenue and earnings always bode well for a company looking for some type of capital event—whether it’s complete sellout or a minority/majority recapitalization. This is reflected in several business valuation methods that a professional may evaluate when it comes time to sell. The Discounted Cash Flow method for business valuations would bolster the value due to the reliability of the forecast. It also means a reduced discount rate of said earnings. In the Multiple of Discretionary Earnings Method, the top factor on the list for a higher multiple is stability of earnings. One of the best ways to create more predictable earnings is through long-term customer contracts.
We have talked before about diversifying the customer base. When a seller can structure his or her business to include both long-term contracts and a customer-base where no single customer holds more than a five percent share of the overall revenues of the business, then value increases further still.
Predictable earnings companies are often labeled “cash cows.” With predictable earnings, the company is able to garner higher demand from multiple buyers when it comes time to sell the business. Some buyers will either completely ignore a potential target that lacks stable contracts or else significantly discount the value of existing earnings because the future remains much less certain.
Stable earnings due to long term customer contracts is one of many factors to consider it comes to building a business that would one day make a superb target to a strategic buyer who may be willing to pay a premium.