Customer Contracts: Preparing for Buyer Due Diligence
- Brandon Chicotsky
- 8 hours ago
- 12 min read
When selling your business, customer contracts play a critical role during buyer due diligence. Buyers closely analyze these agreements to assess revenue stability, customer relationships, and potential risks that could affect the deal or valuation. Key focus areas include:
Revenue Concentration Risks: If a few customers generate 20-30% or more of your revenue, buyers may see this as a liability.
Contract Terms: Problematic clauses like change-of-control provisions, early termination rights, or uncapped liabilities can raise concerns.
Organization: Poorly managed contracts can delay deals. Buyers expect contracts to be indexed, cross-referenced with financials, and stored securely in a Virtual Data Room (VDR).
Missing or Incomplete Agreements: Verbal or undocumented contracts create uncertainty. Formalize these agreements to reassure buyers.
Customer Consents: Some contracts may require customer approval for ownership changes. Address these early to avoid disruptions.
To ensure a smooth process, organize contracts in a secure VDR, resolve unfavorable terms, and maintain compliance with privacy laws. By addressing these areas, you can protect your valuation and keep the deal on track.
Which Customer Contracts Buyers Want to See
When preparing for buyer due diligence, it’s critical to know which customer contracts to prioritize and how their terms might affect revenue forecasts. Not all contracts carry the same weight during this process. Buyers focus on specific agreements that reveal insights into your revenue stability, customer relationships, and any potential deal-breakers. By identifying the contracts that matter most, you can gather the right documents and address potential issues before they escalate. Let’s explore the key types of contracts buyers scrutinize for signs of stability and risks.
Major Customer Contracts and Long-Term Agreements
Buyers typically want to review contracts with your top 12 customers by sales volume. If a single customer accounts for more than 20% of your revenue, it raises concerns about concentration risk - essentially, the threat to cash flow if that relationship ends [1][3][5].
Long-term agreements, especially those lasting 12-24 months or more, are another focal point. These contracts demonstrate consistent revenue and customer loyalty [3][5][6]. Buyers will analyze them for renewal rates, pricing terms, and how well they align with your revenue projections. For instance, a renewal rate above 90% indicates strong customer satisfaction and reliable post-acquisition cash flow [3][5][6]. To support these claims, you’ll need to provide details like sales history, contract duration, pricing structures, payment records, and performance metrics (e.g., service level agreements or SLAs) that highlight your ability to meet customer expectations [1][6][7].
Contracts with Termination or Renewal Clauses
Contracts with early termination rights - such as 30-90 day notice periods or "for convenience" clauses - draw extra attention [3][5][7]. These provisions allow customers to exit quickly, creating uncertainty about whether revenue will continue after the sale. Buyers will want to know how many contracts include these terms and what percentage of revenue could be at risk if customers choose to terminate.
Renewal clauses also come under scrutiny, particularly those requiring renegotiation or offering automatic renewals with opt-out options. These terms can introduce similar risks if your contracts don’t include evergreen provisions or if they heavily favor the customer [5][6]. To reassure buyers, you’ll need to share historical churn data - ideally showing a churn rate under 10% - and demonstrate how this aligns with your sales pipeline. This helps buyers assess whether your customer base is likely to stick around post-sale.
Exclusive Agreements and Non-Standard Terms
Exclusive agreements, such as sole-supplier deals or requirements contracts, can raise red flags for buyers [2][5][6]. These arrangements often limit your flexibility and may hinder growth, especially if the terms are breached after the sale. Franchise or distribution agreements with exclusivity clauses are particularly tricky, as they often include change-of-control provisions that could complicate a sale [2][5][6].
Buyers also pay close attention to non-standard terms like unusual liability caps, indemnities, custom warranties, or restrictive covenants (e.g., volume guarantees) [1][3][7]. These clauses can signal hidden risks to profitability or even customer dissatisfaction. For example, contracts with high refund rates or unfavorable credit terms might hint at quality issues or revenue recognition challenges, both of which could impact valuation [1][3][7].
How to Organize Customer Contracts for Due Diligence
Once you've identified which contracts buyers need to review, the next step is ensuring they’re well-organized and easy to access. Poorly managed documents can slow down the due diligence process and raise concerns for buyers. They expect a clear, complete overview of your customer agreements, and disorganization can lead to delays or even renegotiations of the deal [8]. To avoid this, establish a secure, searchable system that keeps sensitive information protected.
Setting Up a Virtual Data Room (VDR)
A Virtual Data Room (VDR) is an online platform designed for securely storing and sharing confidential documents during M&A transactions [1][6]. It allows you to control access to your customer contracts, reducing the risk of unauthorized access or data breaches. Look for a VDR with features like encryption, audit trails, and detailed permission settings to manage who can view your documents [6][8].
When choosing a VDR provider, prioritize platforms offering features like watermarking, activity tracking, and user-specific access levels [6][7]. For instance, tools like DealRoom let you organize contracts by revenue or expiration date, making it easier for buyers to review agreements with your top customers [1][6]. You can also set permissions so buyers can view documents but cannot download or print them without your approval. Tracking tools such as activity logs and audit trails allow you to monitor buyer engagement [6][7].
These tracking features are particularly useful. For example, if a buyer spends significant time reviewing a contract that accounts for over 20% of your revenue, be ready to answer questions about customer retention or change-of-control clauses [6]. Once your VDR is set up, the next step is creating a detailed index to streamline the review process.
Indexing and Categorizing Documents
Buyers will need a well-organized contract schedule - a comprehensive list of all active agreements with key details like customer name, contract start and end dates, total contract value (TCV), annual recurring revenue (ARR), billing frequency, and renewal dates [8]. This schedule helps prioritize which contracts require a deep dive, such as those with your top 10–20 customers by revenue, while allowing for quicker reviews of smaller agreements [8].
To make this process efficient, create a sortable spreadsheet with essential details like contract dates, values (in USD), expiration dates, and potential risks (e.g., "convenience termination" or "uncapped liability") [1][8]. Include hyperlinks to each contract in your VDR so buyers can easily access the files they need [8]. Group contracts logically into categories such as "Major Customers", "Long-Term Agreements", "Termination Clauses", or "Non-Standard Terms" [1][3][6]. You might also organize them by revenue tiers, such as contracts generating over $100,000 annually, or flag those with change-of-control clauses that could complicate the deal [6][7].
Don't forget to include supporting documents like accounts receivable aging reports, customer correspondence about disputes, and deferred revenue details. This level of organization shows that you’ve done your homework, reducing the chances of unexpected issues that could disrupt the deal [6][8].
Meeting Data Privacy Requirements
Once your contracts are organized, it’s essential to protect sensitive information by adhering to privacy regulations like the California Consumer Privacy Act (CCPA), GDPR (if applicable), or HIPAA [4][10]. This often involves redacting or anonymizing personally identifiable information (PII), such as customer names, addresses, and financial details [4][8]. The goal is to provide buyers with enough information to evaluate your contracts while maintaining confidentiality.
Replace customer names with generic labels like "Customer A" [3][4]. Redact financial details tied to individuals and summarize aggregate data, such as total revenue from your top clients, to safeguard privacy [3][4]. However, keep key terms like pricing, renewal conditions, exclusivity, and liability visible so buyers can assess concentration risks and renewal rates [3][4]. Use redaction tools in software like Adobe Acrobat or built-in VDR features, and have your legal team review everything to ensure compliance [8]. VDR access logs can also demonstrate your commitment to protecting sensitive data, which can help you avoid fines of up to 4% of revenue under privacy laws [4].
For initial reviews, share anonymized versions of contracts [7]. If buyers need full details later, you can provide access to unredacted files after they’ve signed a non-disclosure agreement. This approach balances protecting your customers’ privacy with giving buyers the confidence to move forward.
Common Problems in Customer Contracts and How to Fix Them
Even with a well-organized data room, unresolved contract issues can still cause trouble. These problems often delay deals or lower the value of a sale. The most common challenges fall into three categories: missing documentation, unfavorable terms, and change of control clauses. Tackling these issues before due diligence begins shows buyers you're prepared and helps avoid last-minute setbacks. Let's break down these problems and how to address them.
Missing or Incomplete Contracts
Buyers see verbal agreements, expired contracts, or incomplete documentation as red flags [1][6]. They worry about revenue continuity because they can't verify if your income streams are secure. To catch these issues early, create a list of your twelve biggest customers from the past two years, review sales reports for unfulfilled orders or lost clients, and cross-check accounting records for revenue tied to undocumented agreements [1][5].
Once you've identified gaps, formalize any verbal or partially documented deals and ensure lost customer relationships are properly documented. For incomplete agreements, secure written confirmations or concise summaries of the terms. For instance, if a major client only has invoices on file, draft a simple "Memorandum of Understanding" that outlines the terms and get it signed. Additionally, provide a list explaining any significant lost customers and include updated standard contracts to demonstrate stability [4][7]. Consult with legal counsel to amend agreements where state law allows. These steps help reassure buyers during due diligence.
Unfavorable Terms or Liability Issues
Contracts with risky clauses - like high liquidated damages, uncapped indemnities, auto-renewals, or convenience termination options - can reduce a business's valuation by 10-20% [5][7]. Buyers see these terms as financial risks that could lead to liabilities or revenue losses. Due diligence often includes requests for summaries of warranty claims, refunds, and liability exposures [1][5].
To address these concerns, renegotiate problematic clauses with key customers before the sale. For example, you could limit liability to the purchase price, replace penalty clauses with cure periods, or add language requiring approval for changes [2][5]. A SaaS company, for instance, renegotiated a 3x damages clause to mutual caps before a $10 million acquisition [2][5]. Share redlined versions of the contracts and customer correspondence with buyers to show these updates and build trust [3][5]. Additionally, review pricing terms to include escalation clauses and shorten payment terms from Net 60 to Net 30, which can improve cash flow and simplify the buyer's review process.
Change of Control Provisions
Change of control clauses, present in 30-50% of major contracts, allow customers to terminate or require consent when ownership changes [4][5]. Buyers focus on these clauses to avoid losing revenue post-sale, especially when top customers account for over 20% of sales [1][3]. To find these clauses, search your virtual data room for terms like "change of control", "assignment", "transfer", or "successor" [1][6].
After identifying contracts requiring consent, reach out to customers with letters explaining the benefits of the sale (without disclosing too many details) and request written approval [3][5]. Start this process 60-90 days before closing, prioritizing your most loyal and significant customers [5][7]. Keep track of responses in a consent log for your data room. For example, one manufacturer formalized contracts covering 40% of its revenue, avoiding a 15% valuation drop. Another seller renegotiated critical change of control clauses, securing consents that reduced diligence time from 12 weeks to 4 [5][9]. Resolving these issues early keeps the deal on track.
Getting Customer Consents and Approvals
Identifying Which Contracts Need Consent
Start by reviewing your key customer contracts to pinpoint those that require consent, especially for buyer due diligence. Prioritize contracts with your top 12 customers by sales over the past two years, long-term agreements, exclusive arrangements, and those with unusual terms. Pay close attention to clauses mentioning "change of control", "assignment", "successors", or anything suggesting that a transfer might need approval. These clauses often allow customers to terminate agreements if ownership changes without their consent.
Missing these consents can lead to serious consequences, like contract termination, breach claims, or losing major revenue sources. For instance, one seller lost a client that contributed 20% of their revenue because they overlooked a change-of-control clause that required consent [1]. Some clauses may even trigger automatic termination, while others come with penalties for breaches.
Once you've identified the contracts requiring consent, the next step is to communicate effectively with your customers.
Communicating with Customers About the Sale
After the Letter of Intent (LOI) is signed, reach out to customers through personalized communication, ensuring confidentiality with NDAs in place. Use letters or calls from trusted account managers to explain the request as a standard contract update. Reassure customers that their terms and service levels will remain consistent, emphasizing that the change won’t disrupt their relationship with your business.
Clear and thoughtful communication helps maintain buyer confidence by demonstrating stability in your revenue streams.
"Confidentiality enables businesses to maintain their value without operational disruption or internal discord. Our processes factor this priority in each stage." – God Bless Retirement
Keep disclosures limited to what’s absolutely necessary about the transaction. Avoid public announcements and maintain a consent tracker to log contact dates, responses, and any concerns raised. This ensures you stay organized while addressing customer feedback.
Once customer communication is underway, shift your focus to the timing and legal steps for securing approvals.
Timing and Legal Requirements
Aim to request consents 30–60 days before the closing date. Asking too early increases the risk of leaks, while waiting until the last minute could result in breaches or losing key customers. This timing aligns with the due diligence period when buyers typically review contracts.
Legal advisors are crucial during this phase. They’ll help identify jurisdiction-specific rules, draft consent forms, negotiate waivers for unfavorable terms, and address risks like antitrust concerns. Track all signed consents with proper timestamps and have a system for following up on non-responses. Prepare fallback strategies, such as amending contracts or offering buyer guarantees, in case critical customers withhold consent. This level of preparation reassures buyers that your revenue streams are stable and transferable.
Conclusion
Once you understand what buyers are looking for, the next step is to focus on organizing your documentation. Preparing customer contracts for buyer due diligence isn’t just about ticking boxes - it’s about presenting those contracts as vital assets that highlight your business’s predictable revenue and operational stability [5]. Well-structured and clear agreements make it easier for buyers to see the real value in your business.
Start by centralizing all contracts in a secure virtual data room. From there, resolve any known issues and conduct an internal audit within a 6–12 month timeframe. This process might include creating a master spreadsheet with U.S.-formatted revenue figures, filling in any documentation gaps, and renegotiating terms for high-risk contracts. These steps can help reduce the chances of price reductions or additional escrow demands during the deal.
For many U.S. business owners with companies generating under $25 million in EBITDA, seeking specialized guidance can make a big difference. A firm like God Bless Retirement can manage the entire process - from setting up your virtual data room to collaborating with CPAs, M&A attorneys, and due diligence experts - ensuring your contracts align with buyer expectations and help secure the best possible outcome.
FAQs
Which customer contracts should I focus on during buyer due diligence?
When getting ready for buyer due diligence, it's crucial to focus on customer contracts that stand out due to their long-term nature, high monetary value, or unique clauses. These could include terms like exclusivity, non-compete agreements, or restrictions that might affect operations or finances. Such contracts often warrant extra scrutiny to uncover potential risks.
It's also wise to keep an eye on agreements nearing renewal or termination. These could have a direct impact on future revenue streams, making them particularly important to evaluate. By organizing these documents in a clear and accessible manner, you can simplify the due diligence process and tackle any concerns early on.
What’s the best way to organize contracts in a Virtual Data Room for due diligence?
To keep contracts in a Virtual Data Room well-organized, start by sorting them into clear categories like customer agreements, non-disclosure agreements (NDAs), and contract amendments. Use consistent and descriptive naming conventions so files are easy to recognize at a glance. Including a detailed index or table of contents can also help stakeholders quickly find what they need.
Make sure all documents are accurate and current by scheduling regular reviews. Protect sensitive information by setting up strict access controls and using secure document management tools. A tidy and secure Virtual Data Room not only simplifies the due diligence process but also helps create a strong impression on potential buyers.
What impact do change of control clauses have on selling a business?
Change of control clauses are an important factor when selling a business. These clauses set terms to safeguard existing contracts and partnerships by specifying what happens if ownership shifts.
For instance, they might demand that the buyer meets particular criteria, give the seller or others the chance to renegotiate terms, or even allow for the agreement to be terminated. While these clauses aim to maintain stability, they can sometimes cause hurdles during due diligence. If not dealt with early, they might slow down or complicate the transaction process.