How Customer Concentration can hurt when selling a Business
Posted by Tom Gledhill on Wed, Jul 01, 2009 @ 10:32 AM
Several years ago I was sitting around a table in a conference room helping to negotiate a letter of Intent (LOI) between my client, a small $5M Telecom company, and a prospective buyer. Suddenly a knock came on the door and the business owner opened the door and went outside. He returned about 5 minutes later and beckoned me to follow him outside. "We just learned that we lost ABC Company as a client. They recently hired a new purchasing agent and he decided to go in a different direction. We'll have to end the negotiations and take the company off the market. We also need to cut our staff and restructure the company".
Why was ABC Company so important that they had to cut staff and restructure the company? Because ABC represented 52% of their total revenues! As their business broker I knew that when I took them on as a client, but I rationalized that since ABC was a multibillion dollar company that a strategic buyer would want an "in" to this company that had offices and manufacturing plants all over the globe. That may have been true for just the "right strategic buyer", but finding that buyer was like looking for a needle in a haystack. We had found a buyer who was willing to negotiate, but it was clear that the high "customer concentration" was going to seriously affect my client's value. With the loss of ABC Company not only did the negotiations with the strategic buyer end, but my client was struggling for survival. In the end my client survived as a much smaller company and the owner ultimately transferred ownership to a key employee for a fraction of the company's former value.
This is just one example of how high customer concentration can seriously affect the value of a company. It represents a risk to the buyer, and risk is directly related to a company's value. The buyer mentioned above was fortunate that the loss of ABC Company happened when it did - although the timing didn't have to be so dramatic!
If you, as a business owner, are in a position where one or a few clients represent a big chunk of your total revenue, you must try very hard to diversify your source of revenue so that you're not so dependent on a few large clients. This, of course, is easier said than done. If you can't diversify, or the timeline to accomplish it is long, make sure that you're prepared for the eventual loss of one or more of these big clients. Also, you must accept the fact that your company's value will be seriously affected in the eyes of prospective buyers.