Excess Concentration Risk When Selling Your Business

Excess Concentration Risk When Selling Your Business

Diversification is a well-known strategy for minimizing risk in investments. It’s what you should be doing with investments outside of your business. It is also inside the investment you’ve made in private equity, namely, your business. Use the law of diversification within your business to fortify and protect the business. This will reduce the risk of potential deal killers when selling your business.

There are four areas of concentration that are of concern to business buyers when selling your business:

  1. The Affect Customers Can Have in Selling Your Business

It’s great if you’ve built up a long-term, lucrative relationship with one or two large customers. Unfortunately, this may seem as a risk to potential buyers when selling your business. We have worked with clients who are quite proud that they have developed a long-term relationship with a major client. And over the years, this relationship has become a source of significant revenue for the business. In some cases, becoming the majority of the company’s revenue. We can appreciate the hard work and years of customer service it took to build such a relationship.  As professional brokers we have to point out that from a buyer’s perspective, this could be a red flag when trying to sell your business.

Greater customer concentration equals greater risk. As a business owner, having large customers who want to spend more and more money with you is a good problem to have. And it is hard to turn away orders. On the other hand, the more your business is staffed, organized, and capitalized to support one or two customers the riskier the situation is to the buyer (and current owner also). Recently, we worked with an owner whose business received 85% of its revenue from one big customer. We both knew going into the engagement this would be a huge risk. During the transaction, that client went away and so did the owner’s business. It meant ruin for the owner and the employees, and certainly for any hope of selling the operation for what the owner figured it was worth.

Dilute the percentage of the concentration by building sales with other customers, entering new markets, or consider an acquisition.

  1. How You Can Have an Impact in Selling Your Business

The greater the business’s reliance on your personal skills, efforts, and connections, the riskier it is to a buyer. Will the relationship carry on after you’re gone? Will the customer take orders elsewhere? Make sure that the relationship with the key customer(s) is not dependent on you, the owner of the business. If it is, take steps to introduce one of your sales staff to the client so that future sales are not dependent on your personal relationship with the key client. This cannot be stressed too strongly. If you are vital to an ongoing relationship with any key client, a buyer could view this as a risk and adjust his offer and terms accordingly.

  1. Key Employees Affect in Selling Your Business

If a business depends too heavily on one or a few key employees, this may be seen as a risk by potential purchasers. Will these key personnel stay with the company after a sale? Owners should develop systems and procedures that spread the responsibilities around, diversify the responsibilities, if you will. Have multiple points of contact who can step in for you if needed. Incentives should be provided so that key employees will stay with the business, and they should be required to sign the strongest non-compete agreements that the law allows.

  1. Vendors Affect in the Business Sale

Don’t permit your business to become “captive” to a sole supplier of component parts. Putting all your eggs in one basket has risks and rewards when you’re contracting with a supplier of raw materials, components, products, or services. Many businesses find themselves with a single source supplier.  It is not hard to understand why.  With single sourcing, you manage one known point of contact, reduced purchasing administration costs, and enjoy quicker decision cycles. However, by multi-sourcing, if at any point a vendor fails to deliver on his promise, the client can shift away from that vendor without the time-consuming search and negotiation with other vendors. Additionally, multi-sourcing also allows for ongoing benchmarking. Performance of one vendor can easily be compared to others, as several vendors are providing equivalent services.

If potential buyers feel that your business has lack of transferability and excessive concentration risks, then there is an increased risk that they will either not buy it, reduce the price they are willing to pay, or make a portion of the price contingent upon the business’s future performance. Taking steps to manage the risks associated with concentration issues will help ensure the rewards outweigh the risks.

The good news is that most of these can be avoided through solid preparation and advice.

Need a professional to help plan a successful exit strategy?

A professional business broker can identify and help you tackle other steps based on the specific circumstances of your business.

You can also download our Selling a Business Checklist, which offers insight into how to get your business ready to sell:

If you need help putting together a strategic plan, please contact the Benjamin Ross Group at 215-357-9694 to speak with a business broker who can help you start the process.