Customers are a key consideration when undertaking due diligence during an acquisition. A business may carry risks in relation to their customers such as:
- Relying too heavily on specific customers
- Relationships with the customers tied to key staff in the business
- Provisions in customer contracts which may be unfavourable or onerous
In this article we consider these risks and what you can do as part of the due diligence process to address them.
Customer concentration
Customer concentration refers to the contribution of the business’s customers to total revenue. A business which relies too heavily on a small number of customers to contribute a large amount to revenue is at risk of significant decline in profitability if those customers are lost.
A list of customers and their contributions to revenue should be requested from the seller during due diligence. Following this, an analysis should be performed which summarises the contribution of the customers to total revenue. An example of an analysis is one which analyses the contribution of the top one, three, five, and ten customers as a percentage of total revenue.
Upon performing the initial analysis, a list of queries could be prepared over which you could perform research or enquire about with the seller. Queries could include:
- Is this customer concentration expected within the industry?
- For the customers with the largest contribution to revenue, what type of contracts are in place? Are there fixed contracts? Are the contracts long term or short term?
- How much influence do the largest customers have over the business’s pricing?
It might also be worth considering if the business expects the customer concentration to change in the future depending on the pipeline of work pending or secured. This could be reflected in the financial forecasts which the business has prepared.
Personal relationships with customers and key staff
Over a period of time, key staff members or the owners of the business may have developed close and personal ties with the business’s customers. If those staff members or owners were to leave the business after a restructure post transaction, there is a risk that the customers whom they had close relationships with could also leave.
It may therefore be worth asking the seller whether such relationships exist with customers and the contribution to revenue of such customers. If the business cannot be profitable without these customers, then the risk should be factored into the purchase agreement.
Customer exit clauses and other customer contract issues
Where there are contracts in place with customers, these should be requested as part of due diligence for better understanding of the obligations between the customer and business.
While fixed contracts with customers guarantee a steady stream of revenue, such contracts might become onerous if they contain fixed prices which are no longer profitable for the business going forward. Contracts may also contain exit clauses which allow the customer to terminate the fixed contract upon change in ownership of the business, thereby potentially brining in uncertainty if the business heavily relies on the customer to contribute to future revenues.
It is best to have a clear understanding of customer relationships through reading the contracts in place between the business and customer so that any risks identified can be factored into the purchase agreement.
Find Out More
Groves & Partners are expert transaction advisors, with significant experience in undertaking due diligence for an acquisition.
To find out more about our transaction services please phone us on 1300 892 717 (+61 2 7208 7970) or email info@groves.com.au.