Valuing Your Business: Clients Make all the Difference

At some point, every entrepreneur will want to know the value of his business, whether it might be for strategic planning, estate planning, or preparing for the sale of the enterprise.

There are many key factors in a company’s valuation assessment, including financial performance, industry dynamics, management strengths and weaknesses, competition, and technology. The most important factor, and the one most relevant to any collection business, is its makeup of clients. After all, that is where the revenues are derived!

For collection agencies in particular, the quality of earnings is impacted most heavily by the quality of its customers. A valuation assessment will look at the risk factors associated with the continuing patronage of the firm’s customers. Are they credit worthy? Do they remit payment within terms? Is there reasonable retention of customers relative to industry standards? Are they a diverse array of organizations or are they a narrow type of customer? These are all key factors in assessing risk.

For many firms, the biggest risk component of their current business model is a concentrated clientele. The assessment of concentration always takes into account the specific organization and industry of the entity being valued. It can be universally applied that the more diverse and voluminous the clientele, the less the risk; the loss of no one client would be material, no one client can dictate unreasonable terms and conditions, and the payments of no one client materially affect the financial condition of the company.

Of course, business operators loathe turning down business – especially from their largest client. The difficult balance is in expanding the enterprise with the broadest possible mix of clients/customers given the realities of the marketplace for that business/industry. There are many successful firms that grew by the benefits of a small cadre of clients; conversely there are many instances of growing firms destroyed by the loss of a key client. When assessing value, the determination of risk associated with a concentrated client-/customer-base takes into account the specific market realities.

Valuation theory is highly subjective, but with respect to client concentration, the actual risk associated with too few clients providing too much of the revenue mirrors closely the negative valuation impact of that concentrated clientele. Potential buyers would similarly assess the risk, and modify their value assessment accordingly. After all, the most important asset of an ongoing enterprise is the revenue stream.

There are no automatic formulas to apply globally to determine a potential value reduction; each case needs its own analysis. In strategic planning for your business, development of the client/customer base is clearly a crucial issue. If you are building your exit strategy, keep this in mind and take a close look at your client list as if you were a potential buyer. If you have a major client who represents a large percentage of your revenue, a focused effort now to expand your client base may make your firm more attractive to potential buyers in the future.

David Lavine is the leading valuation expert in the credit and collection industry. He provides business valuation and advisory services to select clients. For more information about valuation services from Kaulkin Ginsberg, contact us at hq@kaulkin.com.