One factor buyers consider when considering purchasing a business is the number of customers it has. For many small to mid-size companies, customer concentration or having too few customers providing too much revenue is a serious risk factor. It’s risky for the business owner in several ways and a red flag for buyers.
For business owners, having just a couple of large customers can feel comfortable. They stop spending money on sales and marketing because they have a steady and familiar source of revenue. They spend less time on administration because they have fewer sources for orders and billing. It can sneak up on an owner; after a while, you may find you have customers that are simply too big to lose.
We’ve seen companies where over 50% of the annual revenue came from one customer. And that’s bad for business. It’s bad because the company loses all leverage with its customers; if the customer decides to change the price they’re willing to pay or change their payment terms, the business owner has no choice but to accept the terms.
The business owner must also worry about changes in the relationship. If new staff come in and the relationship becomes strained, the business owner simply has to put up with it. A merger or acquisition could mean that the customer completely changes the way they do business; they may even bring in their own vendors and start to reduce the amount they spend with you.
Almost any industry sector can be hurt by a shift in the economy, and you may find yourself doing business with a company in trouble. If your customer runs afoul of regulators, makes bad business decisions, has workers who decide to strike, or runs into financial difficulties, your company is in trouble, too.
Buyers recognize these risks, and they’ll want substantial mitigation if they’re going to make an offer for your company. They may require an earn-out, more seller financing, or request a Forgivable Promissory Note (FPN.) The FPN is a tool for buyers to make higher offers with reduced risk. It’s a portion of the purchase price paid back over time and tied to future performance after a sale. It’s a buyer’s way of ensuring the company can survive even if one of the too-big-to-lose customers goes away. If the customer disappears, all or part of the Seller Note may be forgiven. This is obviously a bad outcome for any Seller.
The best time to start fixing the problem of customer concentration is right now. Depending on your business niche, it is recommended that no single customer represent more than 20% of your revenue. For some sectors, that figure may need to be much lower. Diversifying your customer base requires the investment of time and money, which is why we always advise owners to keep some sales and marketing programs in place; it’s hard to start from scratch. But the effort you put in brings many advantages. You can fire a toxic customer, choose to pursue more profitable customers, and let less profitable customers go. You become a little more recession-proof, especially if you diversify the industry sectors you serve.
And your company becomes more attractive to buyers when you’re ready to sell. If you want to maximize the value you get from your company’s sale, pay attention to customer concentration.
