How to structure a deal with heavy customer & vendor concentration?

March 28, 2024

by an investor from University of Oklahoma in Oklahoma City, OK, USA

Hey Searchfunder Community-

I'm seeking feedback on a deal that we’re looking at buying for my wife. The business has been around for 12 years, it’s run remotely by a husband and wife team, no other employees. The husband does sales and logistics (40 hours per week), the wife helps with admin work (20 hours/week) and they’re wanting to retire. They import products (one product-many different shapes/sizes/variations) from India and have a third party here in the US assemble, package and deliver the product to their customers (big box retailers), so they don’t touch any of their products. The asking price is $2,000,000 with $150K of inventory included. SDE has been adjusted for one of the owners.

2023 Revenue-$6,900,000 SDE $800K

2022 Revenue-$7,010,000 SDE $565K

2021 Revenue-$8,750,000 SDE 625K

The bad part, one customer makes up 80% of their sales! Also, they only have one agent in India that sources products from 20 different vendors and they only have one vendor here in the US for assembly.

With the contracts they have in place with the big box retailers, they think (and I think I agree) it would make more sense to structure this as stock sale (LLC).

We think we can grow the revenue and reduce, not eliminate some customer concentration.

With that much customer and vendor concentration, how would you go about structuring an offer that would be a win win for both parties? Let me know what other information I left out that would be helpful. Thanks

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

From a structure perspective (and outside of typical diligence considerations), the three ways to protect yourself from the loss of customer contracts/concentration of revenue is to require the seller to have some “skin in the game.” There’s three ways to do this:

1. Rollover Equity - 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.

2. 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 those key contracts and may even go to bat for you/ keep one foot in the business to ensure you retain your customer base.

3. Seller note- I prefer an earn-out to a seller note for the buyer, given the contingent nature of an earn-out, but a 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. You could try an earn-out/seller note combo, but if the seller is remotely sophisticated they won’t go for it.

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 Michigan in Detroit, MI, USA

As a general rule, and as I'm sure you know, it is always better to buy assets. Your reason for suggesting a stock sale makes sense. But you cannot know for sure until you have reviewed the company's material contracts. For all you know, the customer contracts include change of control provisions, meaning even if you buy stock you will still need to secure customer consents.

Also, if you only need to secure the consent of a limited number of third-parties (be it customers or otherwise), an asset deal may still make the most sense. It's okay that you do not know the answer to this question in advance. Just make sure that the LOI clearly explains that an asset and stock deal are both on the table pending diligence.

As for further ways to protect yourself: Make sure that the eventual purchase agreement contains a material customer / supplier seller representation--asking seller to represent that he and she have no reason to think that a material customer or supplier will stop working with the business for X number of years. Tie that into a specific indemnification backed up by a seller note and an offset right. You could also negotiate a payment holiday on the seller note. But be aware that these are just ways to offset risk. it sounds like loosing one of the big customers or the supplier could still be really damaging for the business.

Let me know if that helps. Always happy to discuss further. Either DM me here or email me at redacted My firm specializes in small market M&A. Glad to share our experiences with you.

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