Customer concentration risk and pricing

by a searcher from Iowa State University - College of Business

2 months ago

Hi all,

how do you think about customer concentration risk when it comes to pricing a deal. I’ve run into several speciality contractors who have some significant risk (one at 80% of revenue to one client!). My view to date has been to reduce the multiple, but brokers don’t seem to agree on that and banks don’t seem to want to touch those kind of deals at all. 

any experience doing a deal like that?

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lender from Eastern Illinois University

You can do forgivable seller notes with SBA financing, so that is an option if you want to use SBA to take some of the risk off the table. Customer concentrations are always a cause for concern and I believe the seller will have to carry more of the risk.

2 months ago | like reply | 0 likes

professional from University of Notre Dame

There’s a few ways to address customer concentration - See below for a suite of potential options (I've included an earn-out here, but flagging that's its not an option under traditional SBA lending):

1. Earn-out - Make a sizable percentage of the purchase price contingent on revenue targets and payable on an earn-out schedule. Seller will want to ensure you keep that key contract and may even go to bat for you/ keep one foot in the business to ensure you retain your largest customer. Not available with SBA lending program.

2. Seller note- If using SBA financing, a forgivable seller note could also incentivize a seller to assist the new owner with securing/retaining existing customer revenues since the seller won’t be paid in full unless the company can maintain its business performance.

3. Partial Buyout - In the stock sale scenario, this is simple- you do a partial buyout and the seller retains a percentage of the business. In an asset sale, no equity is being transferred (nothing to rollover), so you’d have to buy the assets with your LLC/Corporation and then issue the seller equity in your LLC/Corp. Seller would get double taxed in that scenario, so a stock sale is always cleaner for rollover equity. Incentivizes the Seller to help retain the largest customer contracts because they'll still have "skin in the game" and will want to hold on to the business upside.

4. Post-Close Consulting Agreement - Occasionally the Seller would be willing to take a reduced purchase price (or "move around the economics") if you offer a post-closing consulting agreement whereby the Seller would get paid out a commission for certain revenue milestones being hit. This isn't an earn-out since it's not part of the purchase price and can be tied to performance under important customer contracts. It just keeps the Seller engaged with economics tied to the retention of customer revenue.

I do deals of all sizes with bespoke structures. Happy to dig in a bit more- feel free to DM me or shoot me an email --@----.com

2 months ago | like reply | 0 likes

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