1/ The single most common mistake we see in small business acquisition?
CUSTOMER CONCENTRATION
If one customer accounts for >25% of revenue. Just. Don't. Do. It.
Why?
CUSTOMER CONCENTRATION
If one customer accounts for >25% of revenue. Just. Don't. Do. It.
Why?
2/ i. Largest Customer Leaves
And crushes the business financially - the most obvious downside: 30% of your revenue can go up in smoke overnight.
But... this will have an even larger impact on EBITDA & bottom line because of fixed-cost leverage / absorption
And crushes the business financially - the most obvious downside: 30% of your revenue can go up in smoke overnight.
But... this will have an even larger impact on EBITDA & bottom line because of fixed-cost leverage / absorption
3/ Operating a levered small business? A 30-50% decline in EBITDA is often fatal.
4/ ii. Largest Customer Goes into Financial Distress
Many otherwise wonderful, healthy small businesses have gone under because their largest customer entered a period of distress.
Distressed customers not only cut volumes, they also seek price cuts, which leads to...
Many otherwise wonderful, healthy small businesses have gone under because their largest customer entered a period of distress.
Distressed customers not only cut volumes, they also seek price cuts, which leads to...
5/ iii. Largest Customer Demands Pricing Concessions
Are you going to lose 30% of your revenue (see above) or will you give a 10% price concession (which falls straight to the bottom line)?
This happens all the time, but especially during downturns, when it hurts the most
Are you going to lose 30% of your revenue (see above) or will you give a 10% price concession (which falls straight to the bottom line)?
This happens all the time, but especially during downturns, when it hurts the most
6/ iv. Largest Customer Demands New Extended Payment Terms
Often overlooked until you’ve dealt with one dominant customer.
Quick math: all your customers are on 30 day payment terms; the largest, who represents 30% of your revenue, insists on moving to 90 day terms…
Often overlooked until you’ve dealt with one dominant customer.
Quick math: all your customers are on 30 day payment terms; the largest, who represents 30% of your revenue, insists on moving to 90 day terms…
7/ If your business has $10m of annual revenue…
…that means you just lost $500k of cash, gone.
And guess when large customers ask for extended payment terms?
That's right, during downturns when liquidity is at a premium and a small business can least afford it.
…that means you just lost $500k of cash, gone.
And guess when large customers ask for extended payment terms?
That's right, during downturns when liquidity is at a premium and a small business can least afford it.
8/ v. Largest Customer Consumes Disproportionate Amount of Management Time, Resources, Energy & Support
At the expense of other customers & growing the business.
30% of the revenue; 50% of your time…
At the expense of other customers & growing the business.
30% of the revenue; 50% of your time…
9/ But... these are just the reasons why customer concentration is so challenging while OPERATING a business.
It gets even worse when you are looking to ACQUIRE a small business with high customer concentration.
Why?
It gets even worse when you are looking to ACQUIRE a small business with high customer concentration.
Why?
10/ The Seller will ALWAYS have vastly better information about this relationship than a Buyer conducting diligence.
And given the importance to the business, the Seller and the largest customer will often have a close and long-standing relationship.
Which can lead to...
And given the importance to the business, the Seller and the largest customer will often have a close and long-standing relationship.
Which can lead to...
11/ i. Adverse Selection
Existing owner knows something is wrong with the key customer relationship, which drives decision to sell.
Even if not intentionally malicious, a rocky stretch with a key customer may convince a seller it’s time to exit.
Existing owner knows something is wrong with the key customer relationship, which drives decision to sell.
Even if not intentionally malicious, a rocky stretch with a key customer may convince a seller it’s time to exit.
12/ ii. Undisclosed Agreements
Existing owner has made promises to key customer not yet reflected in financials like future price cuts, free product/service upgrades...
These may or may not be documented in writing but do you think the customer will care who made the promises?
Existing owner has made promises to key customer not yet reflected in financials like future price cuts, free product/service upgrades...
These may or may not be documented in writing but do you think the customer will care who made the promises?
13/ iii. Revenue Timing
Existing owner has pulled forward future volumes / orders from largest customer to appear in LTM financials (often in exchange for above)
Given emphasis on Last Twelve Month (LTM) EBITDA in valuation, you would be surprised at how often this happens.
Existing owner has pulled forward future volumes / orders from largest customer to appear in LTM financials (often in exchange for above)
Given emphasis on Last Twelve Month (LTM) EBITDA in valuation, you would be surprised at how often this happens.
14/ These are not hypothetical.
We have seen every single one of the above multiple times.
These issues can, and of course do, also occur in businesses with many smaller customers, but they are less common, more likely to be discovered in diligence and much less impactful.
We have seen every single one of the above multiple times.
These issues can, and of course do, also occur in businesses with many smaller customers, but they are less common, more likely to be discovered in diligence and much less impactful.
15/ You are giving away way too much control over the future of your business to an outside party when you buy a business with that much customer concentration.
Do not let a single customer rise to the level of strategic for your business.
Still not convinced?
Do not let a single customer rise to the level of strategic for your business.
Still not convinced?
16/ 41% of all unsuccessful search fund deals in the Stanford study experienced customer concentration greater than 25%
This was by far the highest cause of "avoidable" failure readily identifiable prior to acquiring the business.
Customer Concentration: Just. Don't. Do. It.
This was by far the highest cause of "avoidable" failure readily identifiable prior to acquiring the business.
Customer Concentration: Just. Don't. Do. It.
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