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Home > Tools and Resources > Ask the Expert > Buying a Business with Customer Concentration Issues

Buying a Business with Customer Concentration Issues

By Richard Parker | Diomo Corporation
Contact Richard Parker | Visit Website | About The Author

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Question:
I am thinking about buying a local transportation and storage company. They have been around for about eight years and specialize in commercial accounts. Only about 25% of the business is residential relocation. The business has grown every year and nets about $175,000 to the owner (including everything). They lease all of the vehicles. They are asking $525,000 for the business and will finance about 50% for a qualified buyer, which I am. The problem is that three of their accounts represent 65% of the business. Of this, almost all of this revenue is related to long-term storage and moving of their stored merchandise. How can I possibly protect myself and what should I be aware of in this situation?

Answer:
This is a GREAT question. In many businesses, one does come across customer concentration issues. However, one must consider the specific nature of the business itself to determine:

  1. Is customer concentration the norm in this particular industry?
  2. What is the impact on the business should the customer(s) stop buying?
  3. How "easy" is it for the customer to go to a competitor? Why would they?
  4. Is there a special relationship between the current owner and the customer that keeps the business safe?
  5. What can be done in the future to lessen this percentage of concentration?

Let's examine all of these points:

As far as protecting yourself, the most effective strategy for any business with customer concentration issues is to establish part of the purchase price as an earn out or performance based purchase. You should also keep in mind that the seller cannot guarantee the revenue to you for perpetuity. If the new owner messes up the business, it is not the seller's fault. However, they should be able and willing to effectively guarantee the business for at least 6 - 12 months. You will need to determine the percentage of revenue/profit each major client represents and then factor this by the multiple being paid for the total business, and then this amount should be evaluated and paid at a future date.

As an example, if you are paying $525,000 for the business on $175,000 owner benefits then this is a three times multiple. If the key accounts represent around $113,000 of the $175,000 this would equate to $400,000 of the purchase price. In 6-12 months you revisit the numbers and if the revenue/profits are still in place, then the seller earns this $400,000 and, ideally, you should build it into the note. If business declines, the $400,000 is adjusted accordingly. In this business, I would suggest a 12 month period since the customer turnover rate is quite low and the clients may take a little longer to evaluate you as well.

Get more expert advice in Richard Parker's How To Buy A Good Business At A Great Price - the most widely used reference resource and strategy guide for buying a business.

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About The Author
Richard Parker is the author of: How To Buy A Good Business At A Great Price, the most widely used reference resource and strategy guide for buying a business. He has purchased ten businesses in his career and has helped thousands of prospective buyers worldwide learn how to buy the right business for sale. He is also founder and President of Diomo Corporation - The Business Buyer Resource Center.

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