Value of service contracts for ICT businesses
Article updated: September 2024
The value of service contracts: are longer term contracts worth more than short term, 30 day notice, contracts ?
Service contracts are a key revenue source for ICT businesses, alongside management services, ad-hoc projects, and hardware/software sales. These contracts provide predictable income and allow for better financial forecasting.
The length of these agreements varies widely, from short-term 30-day notice periods to contracts lasting several years, each with its advantages.
While buyers of ICT businesses often focus on the contract duration, as longer contracts typically offer more stability and attract higher valuations, both short and long-term agreements present unique benefits (as well as challenges), depending on the business’s strategy.
So, does the duration of the contract really matter?
Short term contracts
If there is a contract in place at all, the minimum notice period will be 30 days. So, in theory the client could cancel their contract, pay one further month's retainer and walk away effectively overnight.
Therefore for a prospective buyer, short term contracts represent a significant risk that they will acquire a client base which is able contractually to walk away without allowing time for the new ownership to build their own relationship with the client base.
On the flip side, because of the nature of the industry and the perceived complexity of the ICT systems that are in place, the clients of ICT businesses tend to be very "sticky". With many of the ICT businesses that we talk to, who have short term contracts in place, many of the clients have been with the business for several years and whilst the good quality of service is maintained and pricing remains at the level they signed up to, there is no real reason for them to change their IT supplier.
Short term contracts also represent a smaller hurdle for signing up new clients for ICT contracts and so many ICT businesses use short notice periods as a perk to win more business.
Long term contracts
For the purposes of this article we will assume that a long term contract is for a period of 12 months or longer, with at least a 3 month notice period before the contract renewal date. (Note that this is different from a rolling 3 month notice period once the initial contract period has ended).
Contracts of 2 to 5 years duration are typically seen with ICT businesses which service the financial sector where security of information and sustainability of ICT support is very important.
Long term contracts provide the ICT business with stability and the ability to forecast income and activity. The company is therefore able to plan their future resources and growth in the knowledge that their current client base will remain under contract for a reasonable period of time.
The client base will also tend to be more committed to the ICT business having in many cases carried out a certain amount of due diligence to make sure that the ICT company will meet their requirements and offer a good quality service, before signing up to a long term contract.
So, for a prospective buyer, longer contract terms reduce the risk of the acquisition, and allow the new ownership time to build their own relationship with the client base well before the contract renewal date.
The counter argument to this of course is that if the ICT business is not providing a quality service, it would be in a weak position to enforce the contract agreement should the client decide to stop using and paying for the service. In addition to that, any long term contracts that the buyer considers to be at low / unsustainable prices will also be more of a liability than of value.
So, let’s wrap this all up - does the duration of a contract really matter?
Yes - when it comes to the sale of an ICT business, from the buyer's point of view, the perceived security of long term contracts and the inherent commitment of the client base is highly desirable. It will increase the competition between buyers for your business and will drive up the value of offers made.
However, as long as your business provides a good service at good market prices, both short and long terms can generate favourable revenues and long term clients.
FAQs
- How can I strike the right balance between offering long-term contracts to provide stability while remaining flexible enough to attract new clients with short-term options?
To balance long-term and short-term contracts, you should evaluate client needs and offer flexible contract structures. Long-term contracts provide stability, but offering short-term options with incentives for renewing can attract new clients.
- What strategies can an ICT business use to mitigate the risk of clients leaving when relying on short-term contracts?
For short-term contracts, ensuring high service quality and maintaining strong relationships with clients can reduce the risk of them leaving. Regular check-ins, personalised services, and clear communication about the benefits of continued engagement can help retain clients.
- How can an ICT company ensure that long-term contracts are priced sustainably and don't become liabilities over time?
When pricing long-term contracts, consider inflation, evolving technology, and market changes. Build clauses into contracts that allow for periodic price reviews or adjustments to avoid underpricing your services over time.
Would you like advice on preparing your IT support and telecoms business for sale?
We would be delighted to offer you a free appraisal and indicative valuation of your business to give you guidance on its value and attractiveness to buyers, the most likely deal structure and whether now is the right time for you to sell. Our appraisal can take the form of either a face-to-face meeting or a telephone call, as you prefer.
Please contact us on 020 8090 9380, email [email protected], or complete the form below to arrange an appropriate time to review your exit strategy and the value of your business in confidence and without obligation.
This article originally appeared as part of our series of e-Tutorials for the Sale of IT Support & Telecoms Companies.
