How Customer Concentration Affects Business Valuation
How Customer Concentration Affects Business Valuation
Customer concentration can be an issue when selling your business if any one client accounts for 15% or more of your company’s revenue. It can be a troubling situation to find yourself in because the fewer clients that contribute to your profitability, the greater the chance of losing a sizeable chunk of your income should one or two customers leave.
If this describes your business, you should be taking steps to expand your customer base – especially if you’re thinking of selling. Generally speaking, the less diversified your revenue stream:
- The higher a risk it represents to potential buyers, and
- The lower your business valuation is likely to be
It may still be possible to reap a higher price for your business, however, if you structure its sale to offset buyer risk.
How?
Let’s say one of your customers represents 30% of your revenue. A buyer may be willing to pay one price for the portion of your business that doesn’t rely on that client – 70%, in this case – and do an earnout for the remaining 30%.
In a typical earnout situation, the seller remains involved with their business for an agreed period of time to help keep a lucrative client onboard. If successful, the buyer pays the seller an additional agreed upon amount. If the customer leaves regardless, the seller may forfeit that fee or a portion of the amount.
The downside of an earnout is that it can prevent a quick exit. So if that’s your eventual goal, you should be working to diversify your customer base to strengthen your valuation down the road.
