Key Value Drivers:
Dealing With High Customer Concentration Levels
In this series of articles, we’ve been talking about some of the value drivers business owners should focus on that will help them sell their companies (either wholly or partially) at the highest possible price. Among these value drivers are management team depth and having a strong competitive advantage.
Another key value driver is your company’s level of dependence (or lack thereof) on one large customer for your sales and revenue. The more reliant you are on just one customer, the more financial risk is involved for buyers when acquiring your business.
Heavy Concentration = More Buyer Risk
As a general rule of thumb, no single customer should account for more than 20 percent to 25 percent of your company’s revenue. If the revenue from a single customer accounts for more than this, financial risk is increased because the loss of this customer could have such a big impact on the business.
A high concentration of revenue with one customer can present a dilemma for a business because having a large customer, in and of itself, is a good thing. So no one is recommending that you say “Goodbye” to a large customer just to reduce your concentration risk.
However, you should be aware of the impact that a high customer concentration level will have on the potential sale of your business. If a buyer pays a certain price for your business and then the large customer leaves soon after the purchase is complete, the buyer will likely have overpaid for the business — perhaps substantially.
In short, if a buyer perceives additional risk due to a high customer concentration level, the buyer will probably make the full payout of proceeds contingent on maintaining a certain level of EBITDA in the coming years.
For example, suppose your company’s EBITDA is $5 million and you’ve negotiated a sale for 5 times EBITDA, or $25 million. However, you have one large customer that accounts for 50 percent of your sales and revenue. The buyer might be willing to pay $10 million at closing and $5 million per year over the next three years if revenue remains steady — which, of course, is contingent on retaining the large customer.
If revenue declines substantially over the next three years, calculations would be made to adjust the payout downward to compensate. For example, if revenue fell by half due to the loss of the large customer, the multiple might be reduced to 2 times EBITDA, or $10 million. In this case, you’d receive no additional payouts because you were paid $10 million for the business at closing.
Guarding Against Concentration Risk
The best way to guard against a high customer concentration level is to try to spread out your sales and revenue among a broad base of customers. This way, your business won’t take too much of a financial hit if any single customer is lost.
Of course, this might be easier said than done. If you have the opportunity to land a big new client that will account for half of your revenue, you’re probably not going to turn this down due to concentration risk. But you can ramp up your sales efforts after you land the new customer with an eye toward spreading out your revenue among more new customers in order to reduce your concentration risk.
Also, if you currently have a high customer concentration level and intend to sell your business in order to retire in the relatively near future, you might consider putting your business on the market sooner rather than later. This could enable you to remain active in the business after the sale for a couple of years (assuming the buyer agrees to this) in order to help retain the large customer.
How We Can Help You
At Strategic M&A Advisors, we help owners of closely held businesses identify value drivers that can increase the value of the company to potential acquirers, as well as the company’s selling price. This includes helping you meet the challenges associated with high customer concentration levels.
To schedule a free, no-obligation consultation where we can discuss the particulars of your business in more detail, please contact us at (601) 714 -2777 or send an email.