For a small business it can be great to have blue chip customers – they pay on time and demonstrate good credentials for marketing purposes.
However there are downsides which we have seen in recent months, particularly for companies with significant exposure to Thomas Cook, House of Fraser and others.
A win win…or perhaps not?
There is clearly a mutual benefit to these David and Goliath relationships – the business gets secure, repeatable income and the customer gets the product/service they require at a price they are happy with. But can such a relationship last forever? And what happens when it doesn’t?
The recent demise of Thomas Cook inconvenienced UK customers but it was also reported that many hotels in the Canary Islands have also have had to close their doors as a result. One of the first hotels to close had an exclusive deal with Thomas Cook covering 95% of its rooms up to 2023 . No doubt that deal was much celebrated when it was won but it has now left the hotel and its owners in a precarious position.
It is advisable for companies looking to sell to diversify their customer base
A poorly diversified customer base is a business risk that should be factored into any valuation. Indeed, our corporate finance team frequently advise owner managers looking to sell their business that they should seek to diversify their company’s customer base before inviting purchasers in to go through the books.
We always consider the proportion of turnover represented by each customer over a three year period when undertaking business valuations. If, say, one customer were to be lost, then the value of the business may be significantly affected unless the customer can be easily replaced. Our analysis enables us to consider the likely impact.
If a business is reliant on a small number of customers the risk can be accounted for in the valuation metric (i.e. in the maintainable revenue or EBITDA ) or, more likely, in the multiple used.
In a recent case in which Kate gave evidence the Judge accepted a 50% discount to the valuation multiple to reflect the fact that the business involved was heavily reliant on one specific customer. In a second case Kate valued a facilities management company which had lost a customer representing 45% of its business the month before the valuation took place. Needless to say the business was worth significantly less as a result of the decline in maintainable income resulting from the lost customer.
Reliance on one individual can be similarly detrimental to the value of a company, unless an appropriate handover can be offered.
A similar tale can be told where a business is heavily reliant on one individual, particularly in cases where that individual is considered to be the “brains” behind the business. We recently valued a landscape design business in which both the company name and services were solely reliant on the husband and his unique expertise as the designer. In this case, the value of the business was in the value of the service provided which is intrinsically linked to the individual. Without either the cooperation of the husband or a like-for-like replacement there was little value in the business.
We are often asked to comment on the value of the business under two scenarios – the first where the individual assists with the handover or is retained for a period of time and secondly on the basis that the individual exits the business immediately. Whilst the latter scenario is unrealistic as it would result in a lower selling price in the real world it is strongly argued for by the individual synonymous with the business name. The valuation in the latter case is typically much lower than in a situation where an orderly handover is effected and can eliminate all goodwill from the business value.
This article was originally published in Forensis Autumn 2019.