We have a client in the machining industry with a customer concentration issue. Their big customer is a blue-chip manufacturer, a well-respected brand any company would want to work with, but they account for more than 65 percent of our client’s revenue.
We found our client several buyers, but over the months it took to complete the marketing, negotiations and due diligence something strange happened. This blue-chip customer stopped placing orders.
As far as we know, the customer wasn’t aware of the pending sale. Other signals suggest the relationship is still strong. There’s been no falling out, no known mistakes. But without those sales, our client’s EBITDA went down several million over a seven-month timeframe and the buyer walked.
When selling your business, one of the key value drivers or detractors is customer concentration. The more diverse your customers, the less risk there is to the buyer, and that typically translates into higher value and more cash at close.
Over the years, I’ve seen many companies who’ve grown and built profitable businesses with a limited customer list. You know what to expect of your major customer, and they know what to expect from you.
It’s good work, and these relationships can go on for decades. But at the end of the day, when a buyer looks at your business, they’ll see danger signs.
If you think you’re going to sell in the near future (or even if you’re not), think carefully before you accept that next big contract from your number one customer. Before you invest in a new piece of equipment tied to their business, understand the downside risk.
You can lose that business, even if you don’t do anything wrong. Perhaps your customer gets acquired by someone else with different resources or philosophies. Or perhaps new leadership begins bringing work in house.
Do a risk analysis and understand what will happen if that customer goes away. This is important at any stage of your business, but even more so if you’re nearing retirement.
So what do you do? The first option is clear but difficult: You plan a growth strategy that develops new customer accounts and limits the business you’ll accept from any one large customer.
This gets plenty tricky, of course, in terms of capacity issues and maintaining that pivotal relationship.
Another option is to factor the customer concentration issue into your exit strategy. You might sell years earlier than you originally intended, providing the buyer with a long-term transition in which you stay in the business (either as an employee or a minority owner) to transfer those relationships.
As for our client, we’re in wait and see mode. Maybe the business will come back, but maybe it won’t. We’re reevaluating what the market will bear and helping him readjust expectations.