Its a tough call and something you can only begin to feel comfortable with after diligence....even then, there is no certainty. Diligence takes time and money when you could be spending time on a deal with less question marks. Go with your gut on this....

I would be very hesitant. I encountered a similar situation in one the deals I was working on and decided to walk away. The risk of customers walking away once the ownership changed seemed to be too high.

My rule of thumb is that I will only consider companies where non-owner reps bring in 80% or more of the business. Stopped talking to one when it turned out that the owner personally attends 8+ trade shows per year and is personally well-known in the industry for his expertise. No way I can replace that!

Not uncommon. If you like the fundamentals of the industry and this business, you would want to quantify and try to mitigates "deal-breaking" risks. That level of concentration is not uncommon and you can consider structuring an earn-out to protect yourself/your LPs if business does turn.

You identified a real risk which should impact how you and your capital providers view the deal. This transaction may require a different type of structure and economic incentives for it to work, and might work best as a roll-up strategy (which, of course, would depend on the industry). Happy to talk further if you like, as you probably have to be more creative with a deal like this one. Good luck!

Agree with Hiram. At first glance that business sounds quite stable, and I'd be more worried if the owner told you that he had awful relationships with his customers! If everything else sounds good, get in there and start doing due diligence. That's the only way to confirm/deny some of your uncertainties.

Agree with all the above. Here are some questions that might help you think through the problem: (1) does your target provide a "commodity" product or service, or is "branded" in some way that matters to the customer? (2) Once ownership changes, is there a lower cost supplier they can contract with, because at that point there is no "personal" connection tying them to your target once you assume ownership?

If it's a "commodity" product or service, I would be very cautious. If "branded" in a way that matters (customers trust your target's product or service because of the brand), you're in better territory.

Though it will complicate the deal, a workaround is to keep the incumbent owner on in some capacity: minority equity holder, board member, etc.

I don't necessarily view this as bad, but an area to really dig into during diligence. Understanding why customers choose this business and how they value the importance of the relationship (without asking directly). It may be a huge issue or it may be a huge benefit, but with the information you've laid out, it is not enough to make me walk away. Happy to chat through more if it's helpful.

I have acquired a few companies with customer concentration risks. There is a risk, but I think ultimately if the company you are acquiring delivers good value for their customers most will stay. People generally don't like switching. I think you can negotiate more favorable terms with the seller and perhaps use an earn out tied to retention of key customer relationships in order reduce your risk. If its a lower middle market company I think I would be more concerned if the sellers didn't know their best customers. You should focus on decreasing customer concentration over time by growing the numerator. This way you add value to the company with the increased sales and decreased customer concentration. For me the goal is finding a good company with some flaws that reduces the purchase price, but that I can easily identify and fix to add value.

The customer concentration % you mentioned doesn't sound too bad. Some factors to consider are:
- How long is the owner willing to stay to help with the transition?
- Are they willing to include an earn out or a forgivable seller note tied to revenue/customer retention?
- How does the business' offering compare to other competitors in the market place? Is there a uniqueness? Is the price competitive, or are they getting a premium because customers love the owner and haven't shopped it in a while?
- Do customers have interaction with others in the business (sales, customer service, etc.), or is the owner the primary contact person?
- How does your skill set compare to the owners? Will you be able to step into his or her shoes in terms of maintaining the existing relationships and growing the business?

We interact with hundreds of owners a month in our buyside acquisition searches and frequently encounter owners who are "proud" of their strong customer relationships and often brag about not having a sales team as confirmation of these strong ties. We do not have a clean criteria to support a go / no go decision but add a few key points.
1. Most customers and employees are not as loyal to the owner as the owner thinks. This is true in the corporate world and at almost every level of management. The key is are the clients served well, treated fairly, appreciated for their service or business. If the answer is yes the clients are more likely to stay and give the new owner a chance just as Eric shared.
2. I assume there is other staff that interact with customers in their respective roles so understanding the roles & responsibilities of the staff is very important.
3. We agree that transition assistance is critical regardless of the client relationships status but an owner that is stating his or her relationship is critical is less likely to be of assitance in transition and you should be skeptical if they can actually take the step of letting go. Someone that has owned a business for years can be too emotionally attached. That does not mean you should not acquire that business but you must be certain your transition/consulting agreement provides you full latitude to reduce, limit and stop the prior owner's involvement if they are creating challenges for you moving forward.
4. The client concentration you mentioned does not seem like an issue to be overly concerned about.
5. Long-term contracts with clients are very rare today. Multi-year agreements normally include provisions for early termination and if clients are coming back every few years for additional services that may indicate that it is the past performance of the business not the individual that they know there is why they return.
Good luck

This isn't something the Seller would likely agree to pre-LOI, but you could make it a condition of the LOI that very soon after signing he introduces you to the top[redacted]customers so you can meet them. Most Sellers don't want to do this for fear of spooking customers, but it can be managed. For example you could both agree that the Seller will initially introduce you to the customers as a "potential Investor" rather than an acquirer. Later on when you get to meet them again (or you announce the sale), you can probably come up with a reasonable story that instead of investing you bought the business outright. That might be low risk enough to get you in front of some customers early in the diligence process before you've spent too much time & $. Good luck!

This is a good question!

^[redacted]‌ I have some experience with this in my own business. Custom software development, primarily built on repeat business with a core 10 customers. Each customer has a strong relationship with me. In some cases it was developed after we started working together, but it would be harder for another person to pick up. I've spent time building systems to take me out of the picture, but that's because I am serious about selling in 5-6 years. Couple framing questions I would ask depending on the type of business:

1) Do these repeat customers have an obvious alternative for this kind of product or service?
2) Are there other members of the team that produce value-add, or is the work quality very tied to the owner as well?
3) Is the owner willing to do a customer road show and pass the baton (so to speak) in person?

For #3, in the worst case, you end up with non-compete problems that are very hard to enforce. I have heard a few horror stories about sellers going down the road, pocketing the sale price, and getting all their old customers back. The owner's stage of life could tell you a lot about the risks here. Someone truly retiring is less likely to be a problem than someone "looking for what's next."

The question is the intimacy between customer and owner transferable?

First, the question is whether you can do for the customers what the current owner is doing. This is probably not a matter of personality or friendships but about delivery of value. If the owner delivers deep expertise, maybe that is hard to replicate.

Second, it might be possible to compensate the owner hourly for performing certain key functions that they currently perform with regard to their customers, at least during a transition.

Third, of course an earn out would be useful.

Fourth, in theory, the criticality of the owner should impact price. At the right price, the business will be attractive regardless of transition risk.

I would also make sure that the owner would not interfere in the future of the business or decide he misses the relationships and decide to set up shop again. It may also be an opportunity to get mentorship and someone in your corner that can help with customer conflict that may arise in the future.

1) This not customer concentration at all.
2A) Assume owner has been there for 40 years: I am guessing Company has 20+ customers in one year and a total of 80+ customers who keep coming back every so often. For the owner to have the kind of relationship you are concerned about, the buyers at each of the customers also have to be there for 40 years. My point is decision makers at the customers change. Hence, the relationship has to be with the business for the product/service it provides, Owners are "proud" (Pat Adam's answer) to say they have good relationship with customers. However, that statement is also an indication that this is not a business for an introvert.
2B) Assume owner has not been there for 40 years: If so, clearly the relationship you are concerned about is not as personal as you are concerned about. You should confirm this by asking the customer change before and after he took over
3) In my mind, the attribute "fundamentals of the business" is few orders of magnitude more important than customer concentration of the type in this discussion. Also, there are dozen other types of concentrations that one should be aware of.

Great comments & suggestions by everyone. In my opinion, at the end of the day, you can't afford to speculate, especially not when it comes to revenue/customers. Until you get down in the trenches & talk to them yourself, everything is speculation. When you boil it down, the only thing that really matters is revenue. It's the only thing you are really buying. A company could have the coolest IP/product/service ever but if customers won't pay for it, it's worthless. If you don't feel comfortable or even compelled to dive in with them, it may be a sign of a bigger problem. Don't overthink it or get analysis paralysis, just get out there & find out for yourself. It is the essence of being an entrepreneur & it's good practice to validate that you are truly equipped to take it over. But validating the quality, & longevity of the revenue, stickiness of the product, etc. should be the 1st item you work on because if it doesn't checkout, everything else is wasted time.

Great thread. Like Caleb said, "Don't overthink it or get analysis paralysis, just get out there & find out for yourself."