Customer concentration and the price of your business

Customer concentration lowers the price once one customer passes 30 percent of revenue. In InvestDeal’s valuation engine that takes 0.35 off the multiple, a largest customer under 10 percent adds 0.15, and 10 to 30 percent counts as normal. Buyers also tie part of the price to that customer through an earnout or holdback.

Why one customer can move the whole price

Customer concentration is the share of revenue that comes from your largest customers, and in a business valuation it is one of the first numbers a buyer asks for. When one customer is a large percentage of revenue and you are selling the business, the buyer prices the chance that the customer leaves after you do.

InvestDeal’s valuation engine asks how much of your revenue comes from your single largest customer, and moves the multiple on the answer. The multiple is the number of years of adjusted earnings a buyer pays.

The penalty for a large customer is more than twice the reward for a spread book. Over 30 percent, one customer leaving would change the business, and buyers price that change before it happens. In an auto repair shop that customer is often a fleet account, and in a parts manufacturer it is often one original equipment manufacturer.

How buyers measure it

The request comes on the first day of due diligence, as revenue by customer for each of the last three years. From that one schedule a buyer works out several numbers.

• The largest customer’s share of revenue over the last twelve months, and its share in each earlier year. A share that has grown each year reads as a business drifting toward one account.
• The top five customers as a share of revenue. A business whose largest account is 15 percent can still have five accounts that make up most of the book.
• Gross margin by customer, since a large account on thin margins carries less of the profit than its revenue suggests.
• Concentration under another name. A distributor or an online platform that resells your product counts as one customer, however many end buyers sit behind it. For a trucking company, a freight broker supplying a large share of the loads counts the same way.

The list arrives anonymised at first, with customers as letters, and names follow once a buyer is close to signing. Where your customers are individuals, the federal privacy law PIPEDA permits sharing their information in a prospective sale under an agreement that limits its use to the transaction and requires its return or destruction if the deal ends.

One business, three customer mixes

Take, as an illustration, a commercial cleaning company with $600,000 of adjusted earnings, which is the profit with the owner’s pay and personal costs added back. Cleaning sits in the professional services row, with staffing agencies, at 3.0 to 5.0 times on the industry table, and every other factor stays at its neutral setting.

The same crews earning the same profit are worth $300,000 less at both ends when one client holds 40 percent of the work. The third version also tends to draw offers with more of the price deferred, which the section on deal structure below sets out.

What the contract with that customer says

A buyer reads the agreement with your largest customer line by line. The clauses that matter most decide whether the customer can leave and whether the contract survives the sale.

• The term and renewal tell the buyer how long the revenue is committed. A contract that runs two years past closing is worth more than one that renews month to month.
• A termination for convenience clause lets the customer end the contract on notice for any reason, and the notice period is what a buyer counts as committed revenue.
• A change of control clause gives the customer a right to end or reopen the contract when the ownership of your company changes. It applies in a share sale, where the company itself stays the party to the contract.
• An assignment clause governs an asset sale, where the contract has to move to the buyer’s company. Many commercial contracts make that move subject to the customer’s written consent.

A federally incorporated company has the rights of a natural person under the Canada Business Corporations Act, so it holds its contracts in its own name. In a share sale those contracts stay where they are and the shareholder changes. Share sale or asset sale covers why the choice matters for tax as well. A customer that buys on purchase orders alone can leave on any day, and a buyer prices that customer accordingly.

How deals are structured around one large customer

A buyer who accepts the concentration will usually ask you to share the risk of losing that customer. Three structures are common, and a single offer often combines two of them.

• An earnout tied to the customer pays part of the price later, if that customer’s revenue holds at an agreed level after closing.
• A holdback or escrow keeps a fixed sum back until the customer renews or a set period passes.
• A vendor note, a loan from you to the buyer, carries repayment terms that the buyer may link to the same customer.

Take, as an illustration, an offer of $2.4 million for the third version of the cleaning company. The buyer pays $1.95 million on closing and $450,000 in two equal instalments at the end of each of the next two years, each due if the property manager’s revenue stays at 80 percent or more of its level in the year before closing.

The headline sits in the upper half of the range for the 40 percent version, while $450,000 of it depends on one client. Measured on cash at closing, the offer is $1.95 million. A buyer will also ask to meet the large customer before closing, which is best agreed at the letter of intent with a date near the end of due diligence.

What an owner can do in the year before

1. 01Put the large customer on a written contract with a fixed term that runs past the likely closing date, and ask for consent to assignment on a sale of the business.
2. 02Grow the rest of the book so the large customer shrinks as a share. A customer worth $1.2 million in a business with $3.5 million of revenue is 34 percent, and $500,000 of new work elsewhere brings it to 30 percent.
3. 03Put a second person from your side on that account, so the relationship sits with the company. Selling a business that depends on you sets out how to hand relationships over.
4. 04Hold that customer at its normal margin. A discount given to keep the account shows in the margin by customer, and it lowers the earnings the buyer multiplies.
5. 05Write down the history of the relationship, with the years it has run and each renewal, because a long record is the best evidence that it will continue.

Concentration is one of the four questions in the Quick AI valuation, which shows how your answer moves the range before you give anyone your name. Whether a tool asks it at all is part of how accurate an online valuation is.

The terms used in this piece are defined in the glossary of M&A terms.

Questions owners ask

What counts as high customer concentration?

In the valuation InvestDeal runs, a single customer over 30 percent of revenue is high and takes 0.35 off the multiple. Between 10 and 30 percent is normal, and a largest customer under 10 percent adds 0.15. Buyers also look at the top five customers together.

How much does one large customer reduce the value of a business?

On $600,000 of adjusted earnings, moving from a normal spread to one customer over 30 percent lowers the range by $210,000 at each end, and by $300,000 against a business whose largest customer is under 10 percent. More of the price also tends to be deferred.

Can I sell a business that relies on one customer?

Yes. Buyers price the risk through the multiple and the structure, usually with an earnout or holdback tied to that customer. A written contract with a term past closing and consent to assignment makes the strongest case.

Will the buyer want to talk to my largest customer?

A buyer usually asks for that meeting late in the process. It is best agreed in the letter of intent with a date near the end of due diligence, after the buyer has reviewed everything else and once you have approved them.