Maximizing Value In A Corporate Sale: Business Concentration Issues
Having too great a percentage of your company’s revenue from one or two customers creates business concentration risk, a risk to quality of earnings that will be recognized by any potential buyer. Those important clients/customers may simply take their business elsewhere, rapidly eroding the economics of your business. Even the most airtight supply agreement leaves you with some risk.
Similarly, if your business is reliant on one or two key suppliers, the risk of being cut off will be a red flag to any potential acquirer.
Mitigating these risks seems simple, and sometimes is not. If you can obtain additional customers and or suppliers, do so whether or not you are selling your company. If it is simply not possible, maximizing the value of your business may be best realized by consistently distributing out as much cash as possible, rather than seeking a sale. If you do decide to sell, a transaction containing contingent payments – an “earn-out” – may be needed as a risk-sharing mechanism between current shareholders and a buyer.
Customer and supplier concentration are not the only areas where business concentration risk may exist
If one or two salespeople control most of your revenue, risk flags will fly, as they could opt to leave at any time including after a transaction. If one person controls the flow of financial information or your IT infrastructure, risks arise. If decision-making, even on relatively minor matters, is controlled by one person (perhaps you), risks to both quality of earnings and growth potential exist.
Addressing these types of operational concentration issues are within your control as CEO. If you decide against addressing such issues proactively, you may mitigate risk in a number of ways. Providing bonus payments to key people contingent on staying with the company through the transaction process, and alerting the potential buyer that employment agreements should be arranged with key people are two actions that may mitigate these risks.
Your company can be sold if you don’t address concentration issues relating to customers, suppliers and operational functions. The value will simply reflect the risks to quality of earnings and growth. Those risks will be evident to any competent buyer during the due diligence process.