Question:
I’m considering the purchase of a distributor business I’ve seen and like. My only worry is that one of their customers generates about 40% of the business. How can I protect myself?
Answer:
The seller has to guarantee that this client will remain on board for at least a year.
That’s why seller financing is key: if the customer disappears then you can have a clause to lower the balance of sale.
As an example, let’s say you pay 2 times Cash Flow. And this client represents $50,000/year in CF. If they stop buying within a year then you reduce the Balance Of Sale by 2 times the $50,000 or $100,000.
Your other option is to include an earn out clause whereby you agree on a total price of the business, but “x” amount is not paid at closing and only is awarded to the seller after certain contingencies are met during an agreed upon time frame.
For example, after the first year, if the client is an active customer, the earn out amount is considered to be earned.