โ๐ฐ๐ฑ% ๐ผ๐ณ ๐ผ๐๐ฟ ๐ฟ๐ฒ๐๐ฒ๐ป๐๐ฒ ๐ฐ๐ผ๐บ๐ฒ๐ ๐ณ๐ฟ๐ผ๐บ ๐ผ๐ป๐ฒ ๐ฐ๐๐๐๐ผ๐บ๐ฒ๐ฟ โ ๐๐ถ๐น๐น ๐๐ต๐ฎ๐ ๐ฎ๐ณ๐ณ๐ฒ๐ฐ๐ ๐ผ๐๐ฟ ๐๐ฎ๐น๐๐ฎ๐๐ถ๐ผ๐ป?โ
We sometimes see this scenario when working with business sellers to frame up their business and financials for a sale.
The answer is: Yes, it does affect valuation.
The next question is โHow much?โ and โWhat do we do about it?โ
So hereโs why it matters, and two ideas that sellers in this situation may find useful.
Bottomline: Buyers do focus a lot on customer concentration risk.
๐๐๐๐จ๐ค๐ฃ๐จ:
1๏ธโฃ First, the obvious โ loss of a big customer can cripple the forward earnings potential of the business
2๏ธโฃ This may be an indicator of the fact that the businessโ sales and marketing function is not as robust. The buyer would have to invest in building this out, which would delay future growth
3๏ธโฃ This may also reflect in the companyโs profitability โ sometimes, businesses with very heavy concentration (>75%) have long-time customers who are getting highly favorable pricing (sometimes even at cost) because the business does not want to risk losing them
๐ช๐ต๐ฎ๐ ๐บ๐ฎ๐ธ๐ฒ๐ ๐๐ต๐ถ๐ ๐๐ผ๐ฟ๐๐ฒ:
1๏ธโฃ Lack of long-term contracts (or even annual contracts): If this is not in place, the customer in question may be โre-occurringโ but not really recurring
2๏ธโฃ Risk of customer loss if the customer hears about the sale, or if the seller needs to get customer consent in the event of a sale
3๏ธโฃ Customer is aware that they are a primary customer for the business (meaning that the customer can continue to push for better prices over time)
๐๐ผ๐ ๐ฑ๐ผ ๐๐ฒ ๐บ๐ถ๐๐ถ๐ด๐ฎ๐๐ฒ ๐๐ต๐ถ๐ ๐ถ๐ป ๐ฎ๐ป ๐ &๐ ๐๐ฐ๐ฒ๐ป๐ฎ๐ฟ๐ถ๐ผ?
๐๐๐ง๐ ๐๐ง๐ ๐ฉ๐ฌ๐ค ๐๐ช๐จ๐๐ฃ๐๐จ๐จ ๐จ๐ฉ๐๐ฅ๐จ ๐๐ค๐ง ๐ฉ๐๐ ๐จ๐๐ก๐ก๐๐ง ๐ฉ๐ค ๐ฉ๐๐ ๐:
1๏ธโฃ We strongly encourage sellers to speak to the customer and put in place some commitment agreement. Ideally a longer-term contract but at the very least, terms around minimum order volume or price.
2๏ธโฃ Encourage the seller to start diversifying their customer base immediately โ sometimes this may mean hiring a sales team quickly or developing partnerships that can bring in revenue
There are ๐ฉ๐๐ง๐๐ ๐ค๐ฉ๐๐๐ง ๐&๐ผ ๐ฅ๐ง๐ค๐๐๐จ๐จ-๐ง๐๐ก๐๐ฉ๐๐ ๐จ๐ฉ๐๐ฅ๐จ that we employ, that sometimes also move the needle.
These are dependent on the specifics of the scenario.
If youโre a business leader whoโs contemplating a sale in the future and may have this challenge, reach out to discuss how to address the risk.