(April 27, 4 p.m. EDT) — When the owner of a middle-market business decides to sell, it's a “once in a lifetime” moment. To make the most of it, the owner needs to determine what will make the company attractive.
What makes the business unique? Why do customers use its products and services? In other words, what are the competitive advantages? Are they in the form of hard assets accumulated from years of capital investment, or are they derived from intellectual property, such as patents, trademarks, trade names, copyrights or expertise? These value drivers are the factors that preclude competition and attract buyers. On the other side of the transactional fence, buyers will want to make certain that the businesses they buy will continue to thrive; after all, ultimately they must be able to support the terms of the transaction to their directors.
Just as a business enjoys value drivers, it may also suffer from value detractors, one of which is a problem common to smaller firms: customer concentration. For many buyers, this can be a deal killer. The more customer concentration there is in a business, the greater the risk to its continuity, and often the less likely the interest in the business.
Many middle-market firms are contract manufacturers and job shops. They do not make a product or own the designs or drawings for the production of a product. That doesn't mean buyers will not pursue them aggressively.
However, they often do not have marketing savvy or a marketing or sales staff. Without these departments and personnel, they often become dependent on major customers with whom they have done business for many years. Often, customers of these companies have become successful enterprises and carried their vendors along for a profitable ride. Who would rush to end a relationship with an important customer just because it represented a disproportionately large part of one's business?
Customer concentration then may surely seem to be a value detractor. How is that converted into a value driver? Let's deconstruct some of those characteristics of a business that may seem problematic but may, in fact, be quite the opposite.
Questions to ask include:
* How does the seller compete for its business (price, location, service, quality attributes, etc.)?
* Are there any contracts in place with customers?
* Is there exclusivity in the firm's customer relationships?
* What is the longevity of the relationship?
* How many of the customers' plants does the seller supply?
* Have order volumes been increasing with the customer, both in dollars and as a percentage of purchases?
* Is there a “preferred” relationship with the customer or a title bestowed on the seller that distinguishes it in status from all other vendors?
* Is the relationship between the seller and the customer so important to each that it will end if the seller's owner leaves or sells the business?
The answers will determine the extent of difficulty in executing a sale at an attractive price. The critical challenge is to recognize and emphasize any compelling fit between the seller's business — and its concentrated customer base — and the strategic corporate buyer's own operations.
Here's an example from an injection molding firm. A privately held business of some substantial magnitude was attracted to the molder, even though its revenues were much smaller (about $20 million). All the molder's sales were to the appliance industry, and about 85 percent came from one customer. But the buyer was not deterred.
First, big as the buyer was, it saw a clear set of synergies. The buyer was a metal fabricator that had been trying without success to make inroads with the injection molder's primary customer. The molder had the key that could unlock the door and allow the buyer to not only maintain the plastics sales to that world-class account, but also to initiate sales of metal parts to it.
Furthermore, the injection molder's end market was highly selective about its vendor base and did not routinely look to source alternatives, minimizing the risk of account loss.
While a concentration of a company's business is not generally attractive to most buyers, it does not doom the sale. It is critical not to lose sight of the important catalog of assets to be sold, including client relationships. While having 80 percent of your business with 20 percent of your accounts is not desirable, don't overlook the fact that, for at least your best hypothetical strategic buyer, that 80 percent account may be a prized asset.
Robert Billow is managing director of Billow Butler & Co., a Chicago-based investment banking firm.
