Reduce Your Customer Concentration to Build Business Value

Reduce Your Customer Concentration to Build Business Value

In two recent blogs I wrote about increasing the value of a privately-held IT company by reducing some of the risk factors. In this post I’ll focus on the risk of having an excessive concentration in your customer base. Many small businesses can’t help but have a handful of customers who generate a large percentage of their revenue. This is often a problem for project-based organizations that handle large initial undertakings for their clients. Buyers will usually review any client relationship that accounts for more than 10% of revenue. Although these customers generally involve highly profitable, long-term relationships, you don’t want to become complacent. The loss of one of these key customers could cripple a company, forcing it to post significantly lower revenues and profits.

Due to this risk, buyers will generally apply valuation discounts to companies with a high degree of customer concentration. Many acquirers (especially financial buyers) are wary of companies that derive a majority of their revenues from a few customers. Although some strategic acquirers may be attracted to a company if it has a strong relationship with a particular client, this is the exception rather than the rule.

If this describes your situation, you either need to be able to assure prospective buyers that a special relationship exists with that client or at least explain why the customer can’t easily leave. If you can show that client concentration is a routine occurrence, but the actual customer changes from year to year, that may mitigate the risk for some buyers. At a minimum, you should take steps to start reducing your dependency on that company’s business. Of course you should pay special attention to retain your key customers, but you should also have a program to develop relationships with new clients. Any efforts to reduce the level of customer concentration prior to a sale will help increase the reliability of the firm’s future revenue stream and will also help increase the firm’s value.

Keep looking at your organization from a potential buyer’s perspective and try to make changes that will make it more appealing as an acquisition target (and more valuable, as well). Businesses with a diversified customer base will see a premium over those that don’t— in the eyes of both the buyer and the lender.

In my next post, I’ll discuss the internal management structure and staffing of your company, as well as how each can affect your selling price.