In this series of articles, we are going over the top mistakes business owners make when they decide to sell their business. Selling a business is not supposed to be an impulsive decision. You need to bring your business to a place where it can be valued at its highest and gives you the best returns. You should have a well-planned exit strategy and a systematic approach towards selling your business. Taking preventive and reparative actions well before your business actually goes up for sale is the right way to go.
Learning from other business owners’ mistakes when considering whether to sell your own business can pay huge dividends. Unfortunately, there is a long list of possible mistakes that can kill the sale of your business. (Many of them are being explored in this series.)
Deadly Mistake: Having One Key Customer
The eighth deadliest mistake is when one customer represents more than 10% of the total revenue for that business. This can significantly decrease your business’s chances of selling for top-dollar. You need to know what drives the value of your business, and customer diversification is one such factor.
There are many things buyers look for in a business, such as stability, resilience, market share, projected revenue, and growth. Additionally, customer base is an important driver of the value of your business. Potential buyers seek for businesses with strong financial and organizational structures that do not rely on one single client for more than 10% of their revenue. Buyers hate risk! A broad and diversified customer base represents reduced risk and flexible revenue-generation structures.
Having one key customer with the power to dictate the financial prospects of a company is rather scary to a buyer and a glaring mistake on the part of the owner. The issue with this mistake is that potential buyers will see the danger from afar. If the business happens to lose that customer right after the sales event, it can seriously skew the revenue projections or even the business’ profitability. The new owner of your company can do with as few risks as possible, and a business dependent on one customer for a big chunk of its revenue does not look attractive to most potential buyers.
How One Key Customer Can Stop The Sale Of Your Business
Over-reliance on one or a few clients can be detrimental to the sellability of your business. This situation can not only make the business less attractive, but can also adversely affect the valuation of the business due to the heightened risk involved. You cannot blame the prospective buyers for thinking that this extraordinary dependence on one customer is based on your personal connection with that client. They may be discouraged by the possibility of your key customer taking their business elsewhere, once you are no longer in charge.
This heightened risk may drive the value and consequently the offer and sale prices down. In addition, you may be forced to enter a deal with an unflattering deal structure. In order to shift the risk of potentially losing a key customer to the seller, a buyer may insist on holding a portion of the purchase price in escrow for a certain period of time. Similarly, you may find yourself in a deal where you are the one financing the deal and receiving the earn-out payments based on the earnings of the business over a couple of years.
Depending on one customer for more than 10% of your total revenue is, for the most part, totally unacceptable. However, if you do have a few customers that generate around 5% of your revenue each, it is important that you have the means to prove their dependence on your products and services. This will give the buyers an assurance that they do not have to worry about the business taking a hit with the departure of said customers. When it comes to the value of your business, a loyal customer base is an asset, not a burden!
The Importance Of Diversifying
Having multiple customers driving the revenue generation of your business is important. A broad and diversified customer base, with customers in varying markets that are not affected by the same economic variables can be an added plus. How your business will hold up if the buying power of your customers is affected is critical. If you have customers with different economic, financial, geographic, and industry backgrounds, they are less likely to be affected by the same economic problems — which will largely be outside of their control — giving your business some room to breathe and a chance to recover quickly.
In the best of scenarios, the business should be structured in such a way that any normal customer turnover doesn’t severely impact the business’s revenue projection. It is important that your business does not bestow any of your customers with the power and ability to skew the projected revenue. This is only possible if you do not depend on particular customers too much for your short-term as well as long-term growth and revenue goals. Customers may come and go, yet the business must stand!
Multiple Eggs, Multiple Baskets
Don’t put all of the eggs in one basket, as they say. This saying certainly applies to customer concentration. Lack of diversity does not only enhance the future revenue-risks for the new owner, it drives the value and attractiveness of your business down in other ways as well. It shows a company’s lack of willingness or ability to tap into new and diverse customer bases, lack of interest on part of the customers, inexistent customer confidence, lackluster marketing, questionable usability and appeal of the products and services, etc. In short, a business with only a few customers does not fare well when the time comes to sell.
When planning to sell your business, it is important to do everything in your power to make your business attractive and valuable in the eyes of the potential buyers. Customer concentration may squash your chances of landing a good deal for your business. If you have one or a few customers you depend on heavily for your business’ revenue, you need to mend your ways before it’s too late. By working with a qualified team of advisors, you may be able to address this situation early enough in the process, so that you may take precautionary actions before placing the business on the market.