We don’t care about customer contracts

Conventional wisdom when assessing a potential acquisition is to highly value long customer contracts aka contracted revenue. The idea being is that customers are locked in for the period of the contract and therefore the revenues are assured, and risk of revenue reduction is removed.

This is true. In theory.

Have you ever experienced a customer who is 1-year into a 5-year contract that they do not want to be in? It’s not fun and the reality is, you do not want that customer in your business. They will spit, fight and claw their way out of that contract. The effort and pain of having to do battle with the customer day in and day out when they are trying to trip you up to squirm out of the contract is exhausting; the potential for reputational damage is not worth it. Further, contracted revenue is often a small portion of the average monthly spend so even if the contract remains, there will be a much lower spend then that customer historically had. Much better to agree a settlement with the customer to release them from their contract early and bank some cost-free revenue from them as compensation.

We recently acquired a business where all the customers are on the 3-month rolling contracts. Based solely on customer contract analysis, we should have run a mile. But the customers are posting very high NPS scores (a leading indicator) and very low customer churn (a lagging indicator). So it really didn’t matter about the contract length: the customers are happy and are not leaving so the revenue is safe (and growing nicely).

The bottom line is that you should not overvalue customer contracts when assessing acquisitions.