Most owners do not notice concentration building because the big account is usually the easiest one to serve. It pays on time and the work shows up on a steady schedule. The problem shows up later when a buyer looks at where the money comes from and decides the business is riskier than the profit suggests.
What happens when one account gets too big
If one customer makes up a large share of sales, the buyer knows his return depends on keeping that one relationship. He has no control over it. The people who decide whether the work continues sit inside another company and they can change vendors for reasons that have nothing to do with you.
That concern turns into money terms pretty quickly. Most buyers either lower the price or hold part of it back until the big customer renews or stays through a transition period. Some pass altogether and look for a business where the revenue is spread out.
The first check a buyer runs
The first calculation is simple. A buyer takes your largest customer and works out what percentage of total revenue that customer represents. He does the same thing with the five largest customers combined.
You can run the same numbers from your own books. Pull revenue by customer for the past twelve months and divide the largest total by overall revenue. Add the five largest together and divide again to get the second figure.
Take a business with $1,600,000 in annual revenue. One customer accounts for $480,000 of that total and that customer is 30 percent of sales. Any buyer doing diligence will spot that in the first pass through the financials.
When buyers start to push back
There is no published cutoff that applies to every deal. Buyers judge it by feel and by experience but the pattern is consistent enough that most owners hear the same questions at the same levels.
- Below about 10 percent most buyers do not spend much time on it.
- Once a single customer passes 15 to 20 percent, buyers start asking how long the contract runs and who actually manages the account day to day.
- Above 30 percent a discount is common and buyers often want part of the price tied to that customer staying after the sale.
A signed contract helps at any of these levels because it gives the buyer time. It helps more when someone other than the owner holds the relationship and talks to the customer every week.
Two firms with the same profit
Example: illustrative figures only
Firm A
- Annual cash flow
- $400,000
- Customers
- 40
- Largest customer
- 6 percent
- Illustrative multiple
- 3.0 times
- Illustrative price
- $1,200,000
Firm B
- Annual cash flow
- $400,000
- Customers
- 14
- Largest customer
- 45 percent
- Illustrative multiple
- 2.0 times
- Illustrative price
- $800,000
The cash flow is identical today but the risk is not. Firm A can lose its biggest customer and still keep 94 percent of its revenue. Firm B loses nearly half its sales if one account leaves and buyers price it that way.
The difference here is $400,000 on the same $400,000 of cash flow. Actual deals move around depending on the industry and the buyer but concentration almost always pulls the price down.
How owners bring the number down
There is no quick fix for this. The work is ordinary sales work and it takes time to change the mix.
- Go after midsize accounts that are large enough to move the percentage but not large enough to create the same problem.
- Ask the big customer for a written agreement with a real term and clear renewal language if you do not already have one.
- Keep the big account steady and put your growth effort into the rest of the book so the percentage falls on its own.
Owners who start this work two years before they want to sell usually get a better result than owners who start two months before. The customer list needs time to change and buyers can tell the difference between a recent scramble and a book that has been balanced for a while.
When it still makes sense to sell
A high percentage does not make a business unsellable. For some owners waiting two or three years to bring the number down is worse than accepting a lower price now.
- The big customer is under contract and the agreement still has meaningful time left on it.
- Other people in the company manage the account and the customer is used to dealing with them.
- You have seen the math at the discounted level and the timing still works for you.
That last point decides a lot of deals. An owner who goes in knowing the discount is coming can judge an offer on its merits. An owner who first hears about it during diligence usually has a harder time trusting anything else the buyer says after that.
FAQ
There is no single percentage that triggers a discount in every deal. Buyers get more cautious as the share climbs and a customer above 30 percent draws a discount in most cases.
It helps because the buyer can see how much time is left and what it takes to renew. It does not remove the risk but it gives him something concrete to underwrite instead of a verbal assurance.
A buyer will see it as soon as he asks for revenue by customer so leaving it out does not work. If he finds it on his own the conversation gets harder and the price usually suffers more than it would have with an early disclosure.
We look at these deals case by case. It depends on the contract in place and on how the account is managed and on whether the price reflects the exposure. We try to raise it early so you are not guessing about where we stand.
Wondering how your customer mix will look to a buyer?
We buy established businesses directly and sellers pay us no fees. The first call is a straightforward look at your numbers and at how your revenue is spread across customers with no obligation to go further.
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