By Scott Bushkie
A few years back we took an established manufacturing company to market. This was a profitable operation with well trained staff and a nice facility, but potential purchasers shied away due to one main issue—customer concentration. Approximately 60 percent of the company’s revenue came from one large multinational client.
The owners were confident that their revenue was secure. Their business came from several separate divisions and relationships were well established. Nonetheless, this concentration raised a large red flag and was the main reason many buyers walked.
We found a few purchasers willing to move forward, but they wanted a large portion of the deal structured in seller financing and earn out. With a good part of their payments contingent on future sales, the buyers could reduce their risk from losing this pivotal customer.
Ultimately, after months of negotiations and thousands of dollars in attorney and accountant fees, the sellers couldn’t get comfortable with the large amount of money coming after the sale. At the end of the day, this is one we didn’t get done. The oldest owner, in his 70s, decided not to sell and enjoy the freedoms of retirement, and his son probably didn’t get that extra time he wanted with his family either.
The moral of the story is that customer concentration is a big deal. Many people will say anything more than 15 percent with one customer raises concern. On smaller transactions, the SBA and other lenders look for justification when concentration exceeds 10 percent.
Many business owners get complacent at some point, and that’s expected. Running a business is typically not a sprint from start to finish.
If you’re comfortable and the business is stable, who’s to say you should work harder? No one. But that’s the difference between making money in your business and truly building value, and it will come back when selling business.
That’s why it’s best, three to five years before a sale, to really understand where the finish line is and go out strong. During the last few years, it’s best to approach your business with renewed effort and specific plans to drive value.
Part of that plan should be drawing down any significant customer concentration by bringing in new business.
And these days, not only should you be looking at customer concentration, but also at customer quality. Are they stable, new, heavily leveraged? Buyers are getting savvier, and they’re evaluating customer viability as well as your own.
Diversifying your company is about more than survival. You may “know” in your bones that your customer isn’t going to take his business elsewhere, but a buyer won’t be so confident. Neither will the lenders supporting the deal. A diversified revenue stream, on the other hand, will add value and bring more cash at close.
Scott Bushkie is President of Cornerstone Business Services, a low-to-middle-market M&A firm. Reach him at 888-608-9138 or [email protected]