Increase Customer Diversity, Increase Business Value
A valuable business has a diverse customer base that provides stability as well as revenue.
When selling your business, it is important to know that your customer base has a major impact on its value in the marketplace. A diverse customer base means your revenue comes from a number of clients or customers—not just two or three—and preferably comes from multiple sources other than your primary service.
Simply put, the more customers contributing to your sales revenue without a few dominating that figure, the more valuable your business will be. Why? Because it reduces the risk of serious cash flow issues if one or more customers do not stay under new ownership.
As with all value drivers, it is all about risk. Just as the idiomatic "too many eggs in one basket" strategy is risky, so is a small concentration of customers dominating your revenue.
Potential buyers look for a broad customer base in which no single client accounts for more than 10 percent of total sales. An enterprise serving a multiplicity of customer types, or customers in unrelated industries, that are not affected by the same economic conditions further mitigates risk. Customer diversity measures how insulated from any large-scale domino effect your business is to any reduction in demand or economic problems your customers may face.
Understand your Customer Base
Here are a few things to understand about your customer base and of interest to potential buyers:
- A quick insight into the diversity of your customer base is to run a 'gross revenue by customer report by year.' It will show you the percentage of total revenue each customer generates year-by-year.
- Customer databases contain valuable information that a potential buyer can use as a source of competitive advantage. It has potential to generate future earnings for a new owner and may add significant value.
- What industry sectors do you serve?
- What geographical area do you serve? Are your customers mostly local, regional or international?
- Pay attention to your accounts receivable and aging report because this will indicate if your customers are facing cash flow issues.
Customer Concentration: "Too Many Eggs in One Basket" Scenario
Just as a business enjoys value drivers, it may also suffer from value detractors—one of which is customer concentration. Many small businesses have customer concentration issues, which must be addressed in order to sell the business.
Buyers are typically concerned when an individual customer accounts for more than 10 percent of the overall revenue. It is important to appreciate this concern from the perspective of a potential buyer. This insight can help identify creative deal structures that mitigate the risk in a manner acceptable to both the buyer and seller. The goal is to demonstrate that, while the risk factor exists, the likelihood of losing a key customer is remote.
Common concerns and questions include:
- What would be the impact from the loss of a major customer?
- Is there a customer contract in place? Is it transferable?
- Is there an exclusivity relationship with the customer?
- Is longevity of the relationship of significance with the customer?
- Does the customer have more than one location serviced by the company or purchase multiple products? If so, this signifies that there is a co-dependency and solid relationship with this customer.
- Does the customer enjoy preferential pricing that would be hard to find elsewhere? Is it a high-volume, low-margin customer? If so, the profitability of this customer's loss may not seriously impact the company's bottom line.
- How painless is it for the customer to switch to a competitor and what could cause that to happen?
- Is there a relationship with the current owner and the customer such that the continuity of the customer under new ownership may be uncertain?
- What can be done to reduce this percentage of concentration?
Reduce a Buyer's Concern
A buyer's concern in this area may result in a lower sale price or a deal structure that would bridge the risk gap. For example, a certain portion of the purchase price may be held in escrow for a defined period of time in the event one or more customers are lost post-closing. Another possibility may include earnout payments based on company performance for a specified term. Of course, these deal structures place some of the risk back on the seller, which is not ideal for the seller since operational control is in the buyer’s hands. Another strategy for the owner of a company with customer concentration issues might be to solicit their major accounts to enter into long-term contracts prior to putting the business on the market. Contractual revenues can significantly soothe a buyer’s fear of losing those customers when the business is transferred.
Customer concentration is a serious issue. Retention of major customers through a transition period will be a predominant concern for any buyer. With proper presentation and by potentially structuring a deal that will mitigate some of this transactional risk, the better the probability of a sale and maintaining a fair purchase price.