Why Your Biggest Client is Your Biggest Liability?
If a single customer accounts for more than 15% of your total revenue, you have a severe customer concentration problem. If your top three customers account for more than 30% of your revenue, you are in the exact same unfavorable situation.
To a buyer, customer concentration is not a sign of your excellent service. It is an unacceptable risk vector. You have to look at the deal through the lens of the buyer’s capital structure. Most acquisitions are financed using debt. The lender underwrites the loan based on your historical cash flow.
If your business generates 2,000,000 in EBITDA, but 25% of your revenue comes from one client, the buyer and the bank immediately ask the same question. What happens if that client leaves the day after closing?
The answer is that the business loses $500,000 in EBITDA overnight, the debt covenants are breached, and the buyer's investment goes underwater instantly. No sophisticated buyer will take on that level of binary risk without requiring you to pay for it or share the risk.
When a buyer uncovers heavy customer concentration during due diligence, they will apply a severe discount to your valuation. They will often completely carve out the earnings generated by the disproportionately large customers from the baseline valuation.
For example, they might pay you a 5X multiple on the 75% of your business that is diversified, but put the value of the remaining 25% into a strict, multi-year earnout. If the big client(s) stay for three years post-closing, you get paid. If the big client(s) leave for any reason, including the new buyer’s incompetence, you lose that money entirely. You take all the risk, even though you no longer control the company.
Fixing customer concentration is painful because it often means turning down easy money. You cannot fix the percentage by firing your best client(s). You must fix it by aggressively growing the bottom portion of your client base.
You must redirect your sales and marketing resources away from servicing the large accounts and toward acquiring dozens of smaller, mid-tier clients. The discipline to diversity will reward you very nicely.
A 5,000,000 company with 100 clients with no one account representing more than 5% of revenue will command a significantly higher exit value, with drastically better deal terms (more cash at close, less earnout risk), than a 7,000,000 company where two clients account for half the income. Diversify your revenue or prepare to finance the buyer's risk with your own payout.
With that said, a savvy experienced advisor will help reduce the concentration discount substantially.