M&A Deal Killer Miniseries #1: Client Concentrations
The one issue that could derail any M&A deal is uneven customer concentrations.
Everyone’s heard the saying “the best defense is a good offense”. It’s a mantra that can be applied to a variety of life experiences and has served many people well when using preemptive action to ensure long-term success. While selling a business probably isn’t the first scenario that comes to mind when you hear the phrase, it is definitely an appropriate mindset to have when setting out to task. You’ve spent years, maybe decades, building and growing your business and it only makes sense to recoup on all of that hard work by obtaining a fair sales price and seamless sale. With the challenges of finding the right buyer, financing, and due diligence, the best way to avoid an unexpected bump in the road is be aware of what the potential deal killers are and work to rectify them before the day your business is supposed to close. As part of our mini-series, we are going to delve into what the top 10 deal killers are in middle market business sales and how you can identify, prevent, and repair them.
One of the biggest issues that could deter any buyer from investing in your business is uneven customer concentrations and disproportionate revenue streams. Unbalanced clients concentrations can be the bane of an otherwise sweetheart deal, scaring buyers off due to potential revenue loss and raising a major red flag with lending institutions. More often than not, banks won’t touch a business that has any one customer demonstrating more than 20% of total sales due to the risk and most buyers feel the same way. Uneven client concentrations are one of the most common issues we see with entrepreneurs preparing to sell but the bright side is that the issue is fixable over time. If you think that you might have an issue with client concentrations or if you’re not sure how to find out if you do, we have outlined a full strategy below to help you address the problem and prevent future issues with your customer base.
What are the risks of having unbalanced client concentrations?
The first step to addressing and resolving a client concentration problem is acknowledging how it could harm your business. Uneven client concentrations do not just derail M&A deals, they can become extremely detrimental to your business over time and grow if not properly managed. Here are the potential problems that an uneven customer concentration could cause your business.
- If the client leaves, your cash flow and revenues will suffer and could ultimately lead to layoffs, reduced capacity, and a decreased cash flow.
- Big clients know they are important and will demand more time and resources from you, as well as special pricing, which can hurt your bottom line and impact morale.
- Business owners can often be disillusioned with the revenues brought in by the client and spend less time courting new client or prospecting.
- Big clients often cause time management issues among staff, leading to less time spent on new clients and more time spent catering to them.
- Reduced value of the business during the valuation phase and roadblocks to securing SBA lending.
How can I identify a client concentration problem within my firm?
The next step in fixing a client concentration issue is finding out if you have one and how serious it is. Unless the customer is huge, business owners may actually be unaware of the problem. Generally, if any customer accounts for more than 20% of your revenue, buyers and banks would consider that a problem. To find out the status of your customer concentrations, run a report in your accounting software, Based on what program you are using, the report may be titled something like “Revenue Volumes by Client” or “Sales Percentage by Company”. Once you identify the correct report, run it for the past month, 3 months, year, and then over the past 3 years. One you run the reports, sit down and evaluate. If you discover that for a month or two, your revenues spiked due to a client project or something – don’t worry. Occasional increases in revenue by one client is totally fine, it’s the consistent imbalance that you need to address.
I have a customer concentration issue – how can I resolve it?
While imbalanced customer concentrations and disproportionate revenues streams are cause for concern, they are 100% repairable. The worst thing that can happen is that the problem comes to light when the sale is almost complete or a business owner discovers the issue when they are already burnt out and trying to sell. Fixing a concentration problem does take time, but here is how you can do it.
- Once you have identified at-risk clients, create a list depicting the percentage of revenue they are responsible, starting with the biggest client.
- Set goals on reducing the percentages. Ways to reduce high concentrations could include cutting back on the services offered to that particular client or raising smaller client percentages.
- Invest more time into prospecting new clients. A great way to reduce high concentrations is to offset them with new clients. Alternate the time you spend on the large client with prospecting new ones.
- Upsell to smaller clients. Decrease those high percentages by increasing the smaller ones. Have your sales/service staff focus more on upselling the smaller clients to build their revenue stream.
- When all else fails, have a solid backup plan. Reducing concentrations takes time, it can only help you to have a backup plan in place in case the large client decides to jump ship.
How can I prevent future issues with customer concentrations?
Congratulations! If you have reached the prevention step you have either resolved your concentration issues or do not have any and that is something to be proud of. Fixing unbalanced customer concentrations is a lot of work and the easy way to fix the issue to prevent it from the beginning. Remember that customer concentration isn’t just about money – it can also be the amount of time your team spends servicing the account, which can have the same detrimental effects that financial imbalances do.
- Focus on having 20-30 small to mid-sized customers rather than a few large ones.
- Run and analyze the concentration reports on a regular basis to keep an eye on growing revenue streams.
- Prioritize sales. No customer can become too large if you are constantly on boarding more clients.
- Design a long-term marketing campaign. Marketing takes time to work so implementing a strategy now can help keep high concentrations down and guarantee new customers for the future.
If you have discovered that your customer concentrations have reached an unequal level, do not panic – you are not alone. We have worked with hundreds of business owners who were faced with the same issue and were able to resolve the problem on their own. Eventually, because they had addressed the customer concentration issue, when they were ready to sell the business they were able to secure a sales price between 1-3x higher than the original valuation. As a business owner, it’s critical that you always remain one step ahead of the curve and knowing which potential deal killers threaten the sale of your business will prove to be a beneficial starting point.