A common challenge for many people when buying a business is dealing with customer and/or supplier concentration issues which are quite common in many smaller businesses.

These instances occur when either a disproportionate amount of revenue may be generated by a limited number of clients, or, when a company relies on just a few sources of supply for the products and services that it sells to its clients.

These situations are generally more applicable in product versus service type business, but it is something that every prospective business buyer must be on the lookout for regardless of the type of business for sale they may be investigating.

There are no hard ratios or formulas to follow to determine concentration issues, but a former customer of mine years ago who was in the distribution business always felt that his company had to be solid enough to withstand losing his top five clients or his main supplier.

Interestingly enough, many business owners do not seem to be anywhere near as worried about these types of situations as prospective business buyers are, and they will often discount any concerns that a buyer raises about it. While some may be engaged in good old fashioned salesmanship, conversely, there can be a valid reason for their apathy. Quite often, the owner has operated the business for many years with these concentration issues in place. They (the owner) have a high degree of comfort with the ongoing business generated from the clients. They may have long-term personal relationships with them and it serves to soothe any concerns they have that too much of their business is in the hands of so few clients. As long as the clients keep buying, the owners may not give it a second thought. In other words, they have simply become used to it.

It is quite similar with suppliers. If a business owner has worked with a particular supplier for many years they generally do not pay much attention to what could happen if that supplier stopped selling them, or went out of business.

While these two scenarios may not always be perceived as a threat to a business owner, they can of course, be cause for grave concern to a prospective buyer. After all, if either of these parties disappears, the business could suffer immeasurably.

If faced with this predicament in any business for sale the only option a buyer has is to approach it from a pragmatic point of view. Namely,

you must demonstrate to any seller the specific impact that the business would undergo in the event that these key customer(s) stop buying, or the main supplier(s) stops selling.

Do the exercise to determine what the business would look like in either case, and perhaps

the best solution for a buyer is to structure a performance-based deal that ties the purchase price to the continuation of these clients or suppliers.

Now, you may be saying that could all change if the business has contracts in place with either of these groups. While that may be true in theory, the vast majority of these so-called “contracts” don’t hold much water. Furthermore, if a client doesn’t want to buy from you, or a supplier does want to sell you, there is very little you can do.

You certainly can stipulate that a meeting with these key accounts and suppliers is a requirement to close the transaction, but at the same time, you must be sensitive to the seller’s position of not wanting to make any premature introductions which could potentially derail their business if your deal does not go through.

Others may not even consider the request.

And so, there is a bit of a balancing act required. First, you must decide whether or not you can live with this type of scenario assuming that all things will remain status quo after the sale. In other words, if nothing will change after you take over, will you still be comfortable owning a business with these potential vulnerabilities? Second, there is no guarantee that any of these relationships will continue to perpetuity. As such, can you potentially increase the customer and supplier base to lessen the reliance on so few? If you believe so, then you will want to know why the seller hasn’t done so. This is critical because if they cannot provide a valid reason why they didn’t while they owned the company, then perhaps, they are just giving you a good sales pitch.

If you want to learn more about these types of situations, then read through the various resources about structuring a deal when buying a business.

Have a great week.