Few business owners truly understand the negative impact customer concentration issues have on the potential sale of their companies.
This is especially true when the concentration exists due to a long-standing, highly reputable, or Fortune 500 customer. The seller’s assumption is that due to the size and financial strength of the customer, an acquirer will tolerate the concentration risk in exchange for the opportunity to grow the relationship with the Fortune 500 customer. While there is some merit to this argument, it is rarely enough to close the door on the issue.
In most instances, the “power” that goes along with being a large Fortune 500 customer magnifies the customer concentration issue to an acquirer. Large customers that represent a significant portion of a seller’s business oftentimes dictate the seller’s margin, price, capacity, and/or terms, leaving the acquirer wondering who really runs the business, the owner, or the customer.
Customer concentration risk of any kind, whether the result of a large customer, or small one is almost always a deal killer. Acquirers have a very difficult time getting comfortable with the probability that this customer will remain after a change of ownership. Even if existing management is retained and the investment bankers can establish a price and structure that mitigates the risk to the acquirer, the risk is again magnified when the deal is presented for funding. The equity sources may be willing to assume the concentration risk but the debt sources may not, causing the transaction to crumble.
The good news is that customer concentration risk can be mitigated with a little strategic planning. Jaclyn Ring, a transaction advisor at REAG usually advises her clients to, “Keep their largest customers at no greater than 10% – 15% of their annual revenue. Anything greater than that and things can start to get more complicated,” said Ring.
Todd Torquato, a director at REAG added that timing for implementing a solution is also critical. “Acquirers closely scrutinize earnings over the last three to five years prior to a transaction. So, we advise our clients to have taken steps to diversify revenue prior to this look-back period,” said Torquato.