How Customer Concentration Risk Can Lower Your Business Valuation

A manufacturer with one dominant customer can look strong on paper. Sales are up, the plant is busy and fixed costs are spread over more volume. But when it’s time to sell, customer concentration risk often shows up as a lower offer, even if that customer has no plans to leave.

During a recent Moore on Manufacturing episode, Mike Sibley and Kevin Golden shared valuable insights on what happens when a great anchor customer becomes a concentration risk. The discussion highlighted the importance of understanding your exposure years before you plan to sell.

What Buyers Are Really Paying For

Buyers pay for earnings they expect to keep. When a large share of EBITDA depends on one relationship, they have to ask what’s left if that relationship ends.

The math is simple. Take a company with $1 million of EBITDA where one customer produces $300,000 of it. If that customer leaves, 30% of earnings goes with them, and buyers price that possibility into the deal. Mike put it plainly: “If you’re looking to sell the business in the next year, two years, three years, a significant customer concentration will devalue.”

The result can range from a lower multiple to no deal at all. Mike has seen companies that couldn’t sell because one or two customers made up more than 50% of the business. Even when the large customer is the buyer, it knows how much of the value it controls and will discount accordingly.

Where Concentration Starts to Raise Flags

There is no hard cutoff. In Mike’s experience, though, lenders and buyers start treating a customer as a risk at around 10% of revenue. He has seen manufacturers whose largest customer was anywhere from 10% to 75% of the business.

Revenue Share Isn’t the Whole Story

Two customers that each account for 20% of sales are not equal risks. What matters is what each one contributes. That means contribution margin (revenue minus direct material and labor), gross profit and the cash flow the customer actually generates.

Large customers also tend to ask for price cuts and longer payment terms as their volume grows. Their share of revenue can rise while their margin falls. As Kevin noted, “Just ’cause you’re busy and just ’cause you’re growing doesn’t mean you’re more profitable.”

A yearly review of your customer base on a trailing 12-month basis shows which accounts are growing fastest, how much each is worth and where your exposure sits.

Small Doubts Add Up to a Big Discount

A buyer is stepping into relationships the owner may have built over decades. Any uncertainty about those relationships becomes a reason to lower the price.

That uncertainty often comes from the owner’s own numbers. An owner who thinks a customer is 20% of revenue when it’s really 40% raises concern. So does an owner who can’t say what would happen to the business if that customer walked. Each concern costs a little, and Kevin described how quickly it compounds: “It doesn’t seem like a lot at first until you add those up, and next thing you know, you’re 30% lower than where you thought you’d be.”

How to Bring the Percentage Down

Turning away good work isn’t the answer. The better approach is to keep serving the large customer well and grow everything around it.

Sell More to Existing Customers

Current customers are often the cheapest source of new revenue. You already have the relationship and may already be on their approved vendor list. If they buy one product line from you, find out whether they need others you make.

Build a System for New Customers

A defined target market and a sales process built to win new logos keep growth from depending on a single account.

Watch the Smaller Accounts

When one customer grows fast, the rest of the list can get neglected. Declining sales or slipping margins with smaller customers are worth investigating before those customers drift away.

Start Planning Three to Five Years Out

Concentration takes time to fix, which is why transition planning should start three to five years before a sale. Build a budget and forecast that show your baseline, your risks and your opportunities. Then run the worst case and remove your largest customer entirely to see what remains. Knowing that number early gives you time to change it.

Watch the full Moore on Manufacturing episode to hear Mike and Kevin discuss customer negotiations, working capital and more.

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