SHOULD I REJECT A COMPANY WHERE THE OWNERS ARE (TOO?) CLOSE TO THE CUSTOMERS?
I am seriously considering a company where the owners keep talking up how strong of relationships they have with their customers. They've been in business for 40+ years and have lots of repeat business (no recurring contracts though).
I am trying to figure out the best ways to assess the risk of customer churn if another owner were to come on board (particularly someone like me, without experience in this construction-tangential space). I'd like to do this risk assessment pre-LOI since I think it has a pretty big probability of being an issue.
Two relevant pieces of information for this company:
- Customer concentration is borderline - top 5 customers make up 22-27% of revenue depending on the year
- The business has a lot of repeat business that recurs every 1-4 years but no long-term contracts (a lot of handshake agreements)
What outcomes would you need to see w.r.t typical customer relationships to be comfortable? I can't come up with any concrete go/no-go decisionmaking criteria... without that, there's really no point in going through the exercise at all.
Does anyone have tips on go/no-go criteria as it relates to the customer/owner relationship?
If it's a "commodity" product or service, I would be very cautious. If "branded" in a way that matters (customers trust your target's product or service because of the brand), you're in better territory.
Though it will complicate the deal, a workaround is to keep the incumbent owner on in some capacity: minority equity holder, board member, etc.
I do really like the idea of keeping on one of the owners as a minority equity holder. There are two owners and one is really ready to be done but the second would likely be willing to do that. This strategy gives me a nice thing to offer during due diligence if it becomes even more of a concern.
- How long is the owner willing to stay to help with the transition?
- Are they willing to include an earn out or a forgivable seller note tied to revenue/customer retention?
- How does the business' offering compare to other competitors in the market place? Is there a uniqueness? Is the price competitive, or are they getting a premium because customers love the owner and haven't shopped it in a while?
- Do customers have interaction with others in the business (sales, customer service, etc.), or is the owner the primary contact person?
- How does your skill set compare to the owners? Will you be able to step into his or her shoes in terms of maintaining the existing relationships and growing the business?
1. Most customers and employees are not as loyal to the owner as the owner thinks. This is true in the corporate world and at almost every level of management. The key is are the clients served well, treated fairly, appreciated for their service or business. If the answer is yes the clients are more likely to stay and give the new owner a chance just as Eric shared.
2. I assume there is other staff that interact with customers in their respective roles so understanding the roles & responsibilities of the staff is very important.
3. We agree that transition assistance is critical regardless of the client relationships status but an owner that is stating his or her relationship is critical is less likely to be of assitance in transition and you should be skeptical if they can actually take the step of letting go. Someone that has owned a business for years can be too emotionally attached. That does not mean you should not acquire that business but you must be certain your transition/consulting agreement provides you full latitude to reduce, limit and stop the prior owner's involvement if they are creating challenges for you moving forward.
4. The client concentration you mentioned does not seem like an issue to be overly concerned about.
5. Long-term contracts with clients are very rare today. Multi-year agreements normally include provisions for early termination and if clients are coming back every few years for additional services that may indicate that it is the past performance of the business not the individual that they know there is why they return.
Good luck
These thoughts are really helpful, thanks! It sounds like the consensus is that at least customer concentration for this deal isn't concerning people which is helpful.
1) Do these repeat customers have an obvious alternative for this kind of product or service?
2) Are there other members of the team that produce value-add, or is the work quality very tied to the owner as well?
3) Is the owner willing to do a customer road show and pass the baton (so to speak) in person?
For #3, in the worst case, you end up with non-compete problems that are very hard to enforce. I have heard a few horror stories about sellers going down the road, pocketing the sale price, and getting all their old customers back. The owner's stage of life could tell you a lot about the risks here. Someone truly retiring is less likely to be a problem than someone "looking for what's next."
1) Yes, customers have an obvious alternative for the service
2) The owners are not particularly tied to the value of the service (they have a crew that actually does the jobs)
3) Probably yes, and this is absolutely something I should ask for. The owners seem very ready to retire so that's encouraging that they aren't going to go rebuild it all from scratch.
This particular business actually has a minimal government contracting portfolio, but I absolutely have been seeing high customer concentration in the pure-govcon companies I've looked at!
For #3, I would gauge interest. If they don't understand why you'd want that, that could be a red flag by itself.
Second, it might be possible to compensate the owner hourly for performing certain key functions that they currently perform with regard to their customers, at least during a transition.
Third, of course an earn out would be useful.
Fourth, in theory, the criticality of the owner should impact price. At the right price, the business will be attractive regardless of transition risk.
2A) Assume owner has been there for 40 years: I am guessing Company has 20+ customers in one year and a total of 80+ customers who keep coming back every so often. For the owner to have the kind of relationship you are concerned about, the buyers at each of the customers also have to be there for 40 years. My point is decision makers at the customers change. Hence, the relationship has to be with the business for the product/service it provides, Owners are "proud" (Pat Adam's answer) to say they have good relationship with customers. However, that statement is also an indication that this is not a business for an introvert.
2B) Assume owner has not been there for 40 years: If so, clearly the relationship you are concerned about is not as personal as you are concerned about. You should confirm this by asking the customer change before and after he took over
3) In my mind, the attribute "fundamentals of the business" is few orders of magnitude more important than customer concentration of the type in this discussion. Also, there are dozen other types of concentrations that one should be aware of.