Customer concentration risk and pricing

May 14, 2024

by a searcher from Iowa State University - College of Business in Des Moines, IA, USA

Hi all,

how do you think about customer concentration risk when it comes to pricing a deal. I’ve run into several speciality contractors who have some significant risk (one at 80% of revenue to one client!). My view to date has been to reduce the multiple, but brokers don’t seem to agree on that and banks don’t seem to want to touch those kind of deals at all.

any experience doing a deal like that?

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Reply by a professional
from University of Notre Dame in New York, NY, USA

There’s a few ways to address customer concentration - See below for a suite of potential options (I've included an earn-out here, but flagging that's its not an option under traditional SBA lending):

1. Earn-out - Make a sizable percentage of the purchase price contingent on revenue targets and payable on an earn-out schedule. Seller will want to ensure you keep that key contract and may even go to bat for you/ keep one foot in the business to ensure you retain your largest customer. Not available with SBA lending program.

2. Seller note- If using SBA financing, a forgivable seller note could also incentivize a seller to assist the new owner with securing/retaining existing customer revenues since the seller won’t be paid in full unless the company can maintain its business performance.

3. Partial Buyout - In the stock sale scenario, this is simple- you do a partial buyout and the seller retains a percentage of the business. In an asset sale, no equity is being transferred (nothing to rollover), so you’d have to buy the assets with your LLC/Corporation and then issue the seller equity in your LLC/Corp. Seller would get double taxed in that scenario, so a stock sale is always cleaner for rollover equity. Incentivizes the Seller to help retain the largest customer contracts because they'll still have "skin in the game" and will want to hold on to the business upside.

4. Post-Close Consulting Agreement - Occasionally the Seller would be willing to take a reduced purchase price (or "move around the economics") if you offer a post-closing consulting agreement whereby the Seller would get paid out a commission for certain revenue milestones being hit. This isn't an earn-out since it's not part of the purchase price and can be tied to performance under important customer contracts. It just keeps the Seller engaged with economics tied to the retention of customer revenue.

I do deals of all sizes with bespoke structures. Happy to dig in a bit more- feel free to DM me or shoot me an email redacted

Reply by a professional
from University of Massachusetts at Lowell in Chicago, IL, USA

Customer concentration risk is a significant factor in pricing a deal, as it directly impacts the sustainability of revenue and the business's overall stability. A high dependency on one client, such as 80% of revenue, exposes the acquirer to the risk of losing that client, which should justly depress valuation. Reducing the multiple to account for this risk is a prudent approach, but it often depends on mitigating factors like the client’s contract terms, industry norms, and the business's ability to diversify post-acquisition. In my experience, deals with extreme concentration are challenging to finance, as banks typically view them as too risky without clear diversification plans. While brokers may push back on lowering the multiple, emphasizing the risks to long-term value and financing hurdles can help justify your position during negotiations. It's also possible that you consider an earnout structure contingent on keeping key customers post-close. If you'd like to discuss further, please reach out at redacted

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