Why does one big customer worry a buyer?
SHORT ANSWER
From your point of view, your biggest customer is probably your proudest win especially if they are a big-name brand. However, to the eyes of a buyer who pays today so profits can come in tomorrow, this may be a risk that he will have to price in when he proposes an offer.
Imagine if a business is contingent on one key supplier alone or one key employee? This will make it challenging for a new owner to operate as all his eggs are now in one basket. Ideally buyers want a business that does not rely heavily on a single relationship.
How does customer concentration lower the price?
SHORT ANSWER
Expect harder questions, a lower multiple, or more of the price tied to an earn-out. Moreover, customer concentration also affects financing because lenders who are backing a buyer will identify the same risks and it may affect the buyer’s borrowing ability.
An earn-out ties part of your price to results after the sale, when you no longer control the business. This is why concentration does not just lower the selling price but it can move the parameter from “certain” to “conditional.”
What do buyers check beyond the percentage?
SHORT ANSWER
Buyers do not check the percentage alone, but also revenue by customer, whether your largest accounts are under contract, and who holds the relationship. Rising concentration is a big red flag as it suggests that the business is leaning hard on a few customers in their market.
Buyers often rebuild revenue by customer by month from source to test concentration and churn. They also tend to separate sources of revenue that are continuous like contracts and service agreements, from repeat business that has no commitment.
For the full list of checks, see what buyers check before buying a business in Canada.
Why don't owners see customer concentration coming?
SHORT ANSWER
Internally, concentration looks like a successful cash flow of income for the business, that’s why owners maybe the last ones to notice it and start to add it up for the first time when a buyer asks for that information. Tracking revenue by customer by month makes it visible long before a buyer does the math.
How do you reduce customer concentration?
SHORT ANSWER
You simply need to expand your client circles with more business relationships of similar size and dynamic, so no single client gets to define your business. Moving key relationships from you to your team helps too, because buyers want to know the revenue will stay after you leave. This makes it more appealing to the buyer.
Contracts can also be beneficial. A long-term agreement with a major customer, especially one that transfers to a new owner, reads very differently from a handshake. It is always good to have a written agreement with your long-standing clients no matter how close you maybe with them as these contracts can dictate the outcome of a sale such and can directly impact the business’ value. Here are a few steps you can take to set you up for success:
- Track revenue by customer by month.
- Put key accounts under written contracts.
- Move relationships from you to your team.
- Check major contracts for change-of-control clauses, which can let a customer walk away after a sale.
How does customer concentration show up in due diligence?
SHORT ANSWER
It shows up in two ways:
1) If you can't produce a revenue-by-customer report, expect concentration questions and delays.
2) If a few customers make up a large part of your revenue, the buyer identifies it as a risk and price cuts tend to happen even after a letter of intent was proposed.
A price cut during exclusivity is called a re-trade. The fix is to build monthly revenue by customer from source before going to market, so the numbers a buyer finds match the numbers you presented.
For the other common triggers, see why deals lose value in due diligence.
What this means for you
Make the calculations before a buyer does. Pull revenue by customer for each of the last few years, see who your largest accounts are, and check whether the share they hold is rising or falling.
As mentioned before, this is fixable, even without planning a sale to benefit from. A business that doesn't hinge on one relationship is a stronger business whether you sell, grow or hold.
