Traditionally in service businesses, it’s the job of the sales person to get as many months contracted in for a client as possible. However, looking at my own data on month to month versus fixed term contracts (3 months, 6 months, 1 year) for the last 5 years, there doesn’t appear to be correlation between… Read more »
Traditionally in service businesses, it’s the job of the sales person to get as many months contracted in for a client as possible. However, looking at my own data on month to month versus fixed term contracts (3 months, 6 months, 1 year) for the last 5 years, there doesn’t appear to be correlation between length of contract and lifetime retention of a client. In fact, there seems to be quite a bit of evidence that month to month agreements last longer and have a higher sales close ratio.
The following of course only holds true if you are delivering on what you sell. If you are a company that provides little value and rely on enforcement of contracts as a means of survival, you may as well stop reading now.
There are several reasons why I believe month to month contracts are typically better to sell than fixed period contracts:
- 1. If a company is Non-public and not governmental, your recourse is often limited even if the client defaults or wants to cancel an agreement. How much money and time are you really going to spend enforcing contracts that have values of less than $100k? It would cost more to collect it than just let it go.
- 2. If a client does not like what you are producing in terms of work and want out of a contract early, and you don’t let them, you are going to open yourself to potential online reputation problems and negative reviews. Which in this day and age is very hard and costly to fight.
- 3. The sales close ratio on month to month contracts versus fixed term is much higher because the perception of it is “I can get out whenever I want if they don’t deliver”. Again, as long as you are not over selling your service, and are selling to the right audience, you should not have an issue retaining.
- 4. Fixed termed contracts have an end date, so the accounting department is usually imputing the PO as a fixed-time PO. Once the time is up, your point of contact is reminded of this by accounting, and you have to re-negotiate terms again and go through financial approval processes. If it’s a month-to-month agreement, the PO stays open ended and you don’t need to worry about re-selling it every year.
- 5. If a client does not have the finances to pay you, whether you have an iron clad contract or not, you won’t get the money. So what is the point of having it?
The only time that contracts may be important for the service industry is:
- 1. It’s a governmental or large public company that you are signing an agreement with. These can sometimes be sold to other companies.
- 3. You are getting financing against contracts (PO Factoring or Receivables Loans).
- 4. You are planning on selling your company in the near future. SOMETIMES, Acquirers find value in this, but I am seeing this as a factor less and less.
My experience in buying and selling businesses have been entirely in the digital agency space, but for the most part, all companies look at buying service businesses the same. Below is a non-sequential random list of thoughts and facts you should think about before selling your service business. Getting an LOI is the first step,… Read more »
My experience in buying and selling businesses have been entirely in the digital agency space, but for the most part, all companies look at buying service businesses the same. Below is a non-sequential random list of thoughts and facts you should think about before selling your service business.
Getting an LOI is the first step, but the items below will ensure that the original offer price stays somewhere in the realm of the offer, as well, set you up for success in obtaining your earn out.
- 1. Earn Outs – The dreaded earn out. 95% of the time, when selling a service business, you are going to have an earn out a good portion of the selling price. I would anticipate receiving 20-30% up front, 30% when a year hits, and then maybe a final 35% when you hit the 2-3 year mark or a specific revenue objective. I have asked around and for the most part only 50% of people hit their earn out as planned.
The most important part to negotiate is that you are in control of meeting the earn out terms. As an example, if you have an earn out that is tied to the company achieving a specific profit %, yet the acquiring company is in charge of hiring/firing, you could without any control miss your earn out.
So while I would not be afraid of the earn out, make sure you are in the drivers seat.
- 2. Client Concentration – You don’t want 1 client representing more than 20% of your overall revenue. If you have that, the fear is that once the company is acquired, the client could leave, and the entire acquisition will have failed. So often times if you have one client that represents more than 20% of your revenue, they may discount any revenue/profit for that client. This will affect your overall value.
And while its always difficult to decide how big a single client will be, try to spread out the revenue and sales/marketing focus whenever you can.
- 3. Earnings Multiple – 9 times out of 10, you will sell on a multiple of EBITDA. Basically, Net Income less interest, depreciation and taxes. Depending on how big you are when you sale will greatly impact what you sell for. If you are a $2m a year in revenue company, you might get 2-4x EBITDA. If you are a $10m a year in revenue company, you could get 10-12x EBITDA. The main differences being that if you are a bigger company, you probably have less likelihood that a few bad employees or clients could hurt the acquisition, and the business is probably more scalable in general.
- 4. Ad backs – If you are like most service-based businesses, you probably use your business for all types of expenses that if you sold the company, they would stop. An example might be that you put your car payment through the company, or you inflated your salary. Often times you have expenses that wont exist once the company buys you. These are called ad backs, and as long as you can explain them, you can put them back into your EBITDA calculation and give you an higher exit valuation.
- 5. Net Revenue – Too many times I have seen service-based businesses show their revenue with an inclusion of outside costs like pass through media. In the agency world, a lot of companies count clients spend (Google Adwords for example) in their net revenue calculation. This is not only poor accounting practice, but it will grossly hamper your EBITDA %, which could show you to be a more risky acquisition. A higher or industry average EBITDA percentage implies health and scale. Low EBITDA percentages implies risk. The top line is not as important as fitting into a proper ratio of Net Revenue / Ebitda in accordance with your industry. There is no set percentage, but if you are in the 15-25% EBITDA area you are doing well.
- 6. Vertically specific – If you can appear to be more vertically concentrated, you can often times get a slightly higher value. This is something you need to plan out ahead of time, but usually if half of your revenue is in a specific vertical that the buyer cares about or wants, you can usually justify a 20% premium.
- 7. Accurate Forecasting – This is a huge point that needs real thought put into it. As I stated in #10 below, where you are going is going to be important. They will want to see this in a forecast. The issue is, they are going to likely tie you to this forecast for the earn out. If you miss it, you will drastically reduce what you end up seeing in terms of cash. But you cannot go too light on it as then your buyout will be greatly reduced up front. So put some real time into it and come up with a realistic expectation of where you can be. Don’t put in a stretch goal, you will lose!
- 8. Executive Contracts – This is one of the stickiest topics in any service business acquisition. Even non-equity holding execs that are important to the business must sign an employment agreement or your entire deal could fall apart. One of mine almost did. The good news is that you and the acquiring company are in alignment on doing what’s fair to insure that your most important employees are motivated to make the deal happen. Be transparent to the top guys about a looming acquisition and start early on what reasonable requests might be from him/her.
- 9. Advisement Firms – Unless you know the acquiring company well, I would often times use a firm to help find a buyer and negotiate. Usually their connections will run deep with other advisement firms representing active buyers and they can get a bidding war going. Expect to pay a small monthly fee + 5% of the total proceeds of the sale. Select one with industry knowledge specific to you, it will be money well spent.
- 10. Revenue Acceleration – Buyers buy companies based off of where they think you could be in revenue/EBITDA 2-3 years out. So if you can sell while revenue is climbing, often times you can get a premium by justifying where the company is going to be. If you sell your company during a couple of years of flat (or worse, down) revenue, you just won’t be able to sell your way into a higher perceived value and most likely will only attract buyers looking for low-cost acquisitions.
If you are thinking of buying or selling an agency or service business, shoot me an email I would be happy to offer up any advice.
I know this thought is not a new one, but I figured I would write a post that I can direct people to as I am arguing this point more than I would like to. First off, content is not totally worthless, but writing good content and putting it on your site will not get… Read more »
I know this thought is not a new one, but I figured I would write a post that I can direct people to as I am arguing this point more than I would like to. First off, content is not totally worthless, but writing good content and putting it on your site will not get you to rank, ever. It also won’t help to add to any of your social media profiles. You wont be like Kevin Costner in Field of dreams. If you build it, they wont come, ever.
Do any number of buying-related searches on Google and you will find something very consistent. Large companies dominate the searches. In fact, show me a small or medium sized company that shows up for any number of 1, 2 and 3 word phrases on Google and I will show you a company that is doing aggressive artificial link building. Why? Because naturally they have all of the incoming links due to natural links from large publications, blog haters that write about them, etc.
Google preaches whenever possible that if you build content, they will come. They are lying. They know they are lying, it drives me crazy. Content, on your site, does almost nothing in regards to rankings that will produce real traffic. Sure, you may be able to get an exact match, 5 word keyword phrase ranking that will produce a visit or two each month with content alone, but to get the keywords that drive real volume, the only thing that will get you there is inbound links from other sites. How do you get these? Artificially, paying for them, striking deals, etc. No one wants to say it, but its true.
Our clients are self-educating more and more and often times I am presented with posts and tips from Google preaching NOT to get a link to rank. And then I have to explain to them real reality, not Google’s lies.
They are giving small and medium sized businesses bad advice. In fact, unless you are a company with massive natural PR exposure, you have almost no chance of ranking ever if you followed Google’s SEO guidelines.
The bottom line is, you have to artificially create links in order to rank. Plain, simple truth that is indisputable.