Everyone has 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. You’ve spent years, maybe decades, building and growing your business; it only makes sense to recoup your investment of hard work by obtaining a fair sales price and seamless sale.
With the challenges of confidentially marketing the business, finding the right buyer, financing, and due diligence, the best way to avoid an unexpected bump in the road is to be aware of potential deal killers and work to rectify them prior to the day your business is supposed to close. Our M&A Deal Killers series of blog posts dives into the top 5 business deal breakers in business sales and how you can identify, prevent, and resolve them. We’ll begin with #1: Client Concentrations.
Deal Killer #1: Client Concentrations
One of the most significant issues that could deter any buyer from investing in your business is uneven customer concentrations and disproportionate revenue streams. Unbalanced client 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 risk financing an acquisition loan for a business that has one customer demonstrating more than 20% of total sales due to the risk – and most buyers feel the same way. Uneven client concentration is 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 a problem with client concentration, or if you’re not sure how to recognize if you do, we have outlined a complete strategy below to help you address the problem and prevent future issues with your customer base.
1. Risks of 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 not only derail M&A deals, but they can also become highly detrimental to your business over time if not properly managed. Here are a few of the potential problems that an uneven customer concentration can cause for your business:
- If the big client leaves, your revenues and cash flow will suffer and could ultimately lead to staff reductions, 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 become captivated by the revenues brought in by the client and spend less time courting new clients or prospecting potential business opportunities with higher margins.
- Big clients often cause time management issues among staff, leading to more time spent catering to them and less time on new clients.
- Unbalanced client concentrations lead to reduced business value during the valuation phase and roadblocks to securing SBA lending.
- Prospective buyers might require the seller to provide a longer training and transition period to ensure the transferability of the relationship with the large client.
- Propositions of less desirable deal structures such as earn-outs.
2. How to Identify a Client Concentration Problem
The next step in fixing a client concentration issue is determining if one exists and how serious it is. Unless the customer’s sales are significant, business owners may 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 sales by customer report in your accounting software. Depending on what program you use, the report may be titled something like “Revenue Volumes by Client” or “Sales by Customer.”
Once you identify the correct report, run it for the past month, three months, year, and then over the past three years. Once you run the reports, take time to evaluate them. If you discover that your revenues spiked for a month or two due to a large client project don’t worry. An occasional increase in revenue by one client is totally fine; it’s the consistent imbalance that needs to be addressed.
3. How to Resolve a Customer Concentration Issue
While imbalanced customer concentrations and disproportionate revenue 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 seeking to divest their business right away.
Fixing a concentration problem takes time, but it is possible. Here is how you can do it:
- Once you have identified at-risk clients, create a list showing the percentage of revenue each is responsible for. Start with the biggest client.
- Set goals for reducing the percentages. Reducing high concentrations could include cutting back on the services offered to that particular client or raising smaller client percentages.
- Invest more time toward prospecting new clients. A great way to reduce high client concentration is to offset them with new clients. Alternate the time you spend on current clients 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.
- Hire additional personnel to dedicate their time to servicing new clients.
- When all else fails, have a solid backup plan. Reducing concentration takes time, and it can only help to have a backup plan ready in case the large client decides to jump ship.
4. How to Prevent Future Customer Concentration Issues
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 is 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 client, 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 onboarding 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 in the future.
If you’ve 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 faced the same issue and were able to resolve the problem on their own. Addressing the customer concentration issue on the front end allows the business to maximize the sales price when they are ready to sell.
As a business owner, it’s critical that you always remain one step ahead of the curve. Knowing which potential deal killers threaten the sale of your business will prove to be a beneficial starting point.