M&A Knowledge for the IT Services Business Community.

Covering your Assets: 5 Critical Attributes of Customer Contracts

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Recurring revenue may be king in driving the increased value of IT Service companies today. However, the quality of the Contracts that back up the revenue can make or break you! If you want to maximize value and avoid potholes pay special attention to these 5 Critical Contract Attributes.

  1. Duration
  2. Assignment and Change of Control
  3. Termination
  4. Governing and Jurisdiction
  5. Execution

Duration informs both parties of how long service is expected to continue without interruption and the best agreements run between one and three-years. The longer the contract term, plus the existence of an auto-renew clause with the ability to adjust pricing, can increase buyer confidence and garner a better deal for your firm. The short durations, of course, can undermine your company’s value by increasing risk to the buyer.

Assignment and Change of Control can scare off a buyer. Whether through an Asset or Stock sale, it’s important to know if your contracts can be assigned without consent from the customer. Having no constraints in this area provides the greatest flexibility for a buyer. It’s important to review your contracts and determine if some or all need to be updated.

Termination clauses typically exist for both parties in a contact. If the language is loose and allows the customer to cancel with little notice or obligation, this can undermine the implied strength of the duration described above. A contract with an easy out holds little more value than a handshake service agreement in a buyer’s eyes. If you can strengthen the termination clauses, buyer confidence will follow.

Governing and Jurisdiction clauses can make your life easier in the face of the dreaded dispute. When you’ve lived up to your end of the agreement without being compensated, mediation or adjudication may be necessary. The existence of these clauses can save you time and money in pursuing collections.

Execution is the end-all. A contract is not worth the paper it is written on without the agreement being executed by both parties. By having your customers agree to and sign your agreement, you have created a legal document stating the expectations of both parties and listing any ramifications of not fulfilling those expectations. Should an agreement call for mediation or, worse yet, adjudication, your agreement could be meaningless without signatures. As an aside, your executed contracts should be current! An expired agreement is easily terminated and a red flag for a buyer (see Termination above)

You get the picture? Tighten up your contracts to truly serve and protect your income. We call this “Cleaning House” and you can read more about other recommendations in a previous post “ATTENTION SELLERS! THIS IS A DRILL – What’s in Your Closet?”

Lastly, you may find it worthwhile to have someone walk behind you to evaluate some of these aspects of your business to determine your market value. Read up on Cogent’s Market Value Analysis which can give you helpful insight on areas of strength and those that can be improved in your business to increase value.

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