80% customer concentration

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November 12, 2023

by a searcher from Colorado State University in Fairfield, CT, USA

I'm looking at a commercial cleaning business that does about 1.5MM EBITDA with 80% coming from multiple contracts all under the umbrella of a single university hospital. Most advice tells me to factor this into the asking price, instead of trying to tie seller compensation to it because the seller won't have any control over my performance in the business after they leave. Any advice on how to factor this into the multiple, or another way to mitigate this risk?

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Reply by a searcher
from University of Florida in West Palm Beach, FL, USA
Diversification Risk: The heavy reliance on a single client poses a diversification risk. If the contract with the university hospital is lost or reduced, it could significantly impact the business's revenue and profitability. Valuation Multiple Adjustment: To account for this risk, you might consider adjusting the valuation multiple downwards. Businesses with diversified revenue streams are generally less risky and command higher multiples. Since this business has a concentration risk, a lower multiple might be justified. Contract Stability and Duration: Evaluate the stability and duration of the contracts with the university hospital. Long-term contracts with a history of renewals suggest stability, whereas short-term or unstable contracts increase risk. Due Diligence on the Client Relationship: Understand the nature of the relationship with the university hospital. Is the contract based on competitive pricing, quality of service, or personal relationships? The durability of this relationship post-transition is crucial. Transition Support: Negotiate a transition period where the seller assists in maintaining and transitioning client relationships. This can help ensure continuity and reduce the risk of contract loss post-acquisition. Earn-Outs or Seller Financing: While tying seller compensation directly to future performance is less preferable, consider partial earn-outs or seller financing to align the seller's interest with the business's continued success. Building New Client Relationships: Have a plan for diversifying the client base post-acquisition. This might involve investing in marketing, sales, or expanding services. Legal Review of Contracts: Ensure that a legal review of the contracts with the university hospital is conducted. Look for any clauses that might allow for contract termination or non-renewal upon change of ownership. Contingency Planning: Develop contingency plans in case the contract with the university hospital is lost. This might include financial planning for a decrease in revenue or strategies for rapid client acquisition. Consulting Experts: Consider consulting with a financial advisor or a business valuation expert who can provide insights specific to the cleaning industry and help in accurately assessing the risk and adjusting the valuation multiple.

;)
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Reply by a searcher
in Tucson, AZ, USA
If I was in your position, I would only consider buying the business with a 80% earn out or seller financing thats forgivable due to the wildly outsized customer concentration risk.

The $300k (representing the 20% that isn't from one client), could be offered at the appropriate EBITDA multiple for your industry.

The 1.2M that represents the University hospital should be entirely purchased with the earn out. Losing that contract would mean the complete collapse of your entire business. How the current contract is written and how it renews will also be critical. Your lawyer needs to be specialized in lower-middle market acquisitions and you need to listen to their advice. Walk away from the deal if the risk can't be mitigated properly.
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