Is it ever okay to buy a business with high customer concentration?
August 04, 2022
by a searcher from University of Cincinnati - Carl H. Lindner College of Business in Bear, DE, USA
I have reviewed about 75 CIMs so far and one of the most common issues I came across is high customer concentration. My definition of high customer concentration is that either the top client provides more than 15% of the revenue or top 10 clients provide more than 50% of the revenue.
So, the question for the experts in the community is that whether there is any scenario based on industry or business type where it is okay to buy a business with a high customer concentration and I should do a little more digging than simply walk away?
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
1) How long as the customer been with the client
2) How many products does that customer rely on from that client. If they are only manufacturing or buying one things from that client, it is a larger concern. If they are buying or manufacturing many different products, it is going to be harder to replace that client.
3) What type of contracts are in place with the clients? Do they ensure longer term buying habits.
4) What other competition exists that could replace that business?
5) How competitive is the pricing currently being offered as compared to alternatives in the market.
6) Are there any other strategic reasons why this business is likely to retain these clients over their competitors (turn around times, location, quality, etc.)
7) Can the business sustain losing one of these clients and still generate cash flow.
8) How does the profit margin on the larger customer compare with other customers? Sometimes the largest customer is the least profitable part of the business in some cases the business might generate better margins without that business.
9) What type of relationship does the seller have and how hard is it going to be to transfer that relationship.
These are all items to consider. From a lender perspective we usually prefer to see no customers more than 25% of revenues (again, there are always exceptions) and the top ten customers not more than 100% of revenues. 10 strong customers all at 10% of revenue can make a very healthy company. Please let me know if you have any questions or would like to discuss further at redacted
from University of Southern California in North Palm Beach, FL, USA
This, from one of my how-to books may be useful, too:
Be careful if sales to one customer exceed 10%. (Do cash flow scenarios for various possibilities. Before you make offers.) Do the math. A 10% reduction of the top line (revenue) usually ruins the bottom line (profit). This is one of the first things business buyers, exit planning advisors and business brokers look for when they evaluate companies.
Customer / revenue concentration is rarely a good way to run a business, especially if it exceeds 8%. Every customer whose revenue exceeds 8% is a risk to your business for if you lose one or more of these customers your company can instantly become insolvent. Expect to lose sleep if any customer’s revenue exceeds 10%. But, like most things pertaining to business buying, there is more to the story.
Jeffrey D. Jones, on the topic of business valuation writes: “As an appraiser, the red flag is if any given customer represents 15% of total sales. Even then, it depends. How long have they had the customer? What is the relationship with this customer? Is the company one company or a division of a larger company that also does business with your company? Just a blanket statement not to buy if one customer represents 10% of total sales is too broad. I have actually sold businesses wherein one customer was 70% or more of the business. It does not mean the business is unsalable. It means the price will reflect this risk. Fair Market Value is a range concept. The higher the risk, the lower the price, but there will always be upper and lower limits.”