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Customer concentration

Customer concentration describes how much of a business's revenue comes from a small number of customers. The higher it is, the more the business depends on decisions it does not control.
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Definition

Customer concentration describes how much of a business's revenue comes from a small number of customers. It is usually measured as the share of revenue from the largest customer, and sometimes from the largest five or ten. The higher the share, the more the business's income depends on decisions it does not control.

Worked example

Two fictional UK packaging companies each have revenue of £3,000,000 and adjusted EBITDA of £500,000.

  • Ashcombe Packaging sells to 200 customers, and the largest accounts for 6% of revenue.
  • Brindley Cartons sells to 40 customers, and one food manufacturer accounts for 45% of revenue.

If Brindley's largest customer moves to another supplier, the business loses £1,350,000 of revenue and probably most of its profit. A buyer would pay less for Brindley, or ask for part of the price to depend on that customer staying.

Adjusted EBITDA

Adjusted EBITDA is EBITDA after normalising adjustments, showing what a business would earn with a paid manager in the owner's seat. Larger small-business deals are usually priced on it.

Why buyers care

A large customer can leave, push prices down or change its terms, and it knows how much it matters. Concentration also affects lenders, who may lend less against earnings that rest on a single relationship.

Ask for revenue by customer for at least three years, read the contract terms and renewal dates, and check whether any contract can end on a change of control. Find out who holds each key relationship: if it is the owner, concentration and owner dependence compound each other. Loupe's valuation tool reduces the multiple in steps as the largest customer's share of revenue rises.

Change of control clause

A change of control clause gives the other party to a contract rights if the business changes owner, such as the right to terminate, renegotiate or refuse consent.

Related terms

  • Key person risk

    Key person risk is the risk that a business loses value if one individual leaves or stops performing. In small businesses that person is often the owner.

  • Recurring revenue

    Recurring revenue comes back without being won again each time, through subscriptions, retainers or service contracts. Contracted revenue is the part committed for a fixed term.

  • Change of control clause

    A change of control clause gives the other party to a contract rights if the business changes owner, such as the right to terminate, renegotiate or refuse consent.

  • Earn-out

    An earn-out is part of the purchase price paid only if the business meets agreed targets after the sale. It can bridge a gap between the seller's price and the buyer's view of the evidence.

  • Net revenue retention

    Net revenue retention compares the recurring revenue from existing customers now with the same customers a year earlier, including upgrades, downgrades and cancellations.

Guides

  • Customer concentration and why buyers discount for it

    When a few customers account for much of a business's revenue, the earnings you are buying are less certain. This guide explains how to measure concentration, why it lowers the price and how to shape a deal around a dominant customer.

    9 minutes to read

  • Due diligence: what to check and in what order

    A sequence for due diligence that tests what could end the deal first, while it is still cheap to find out, and leaves the detailed and expensive work until the deal looks sound.

    10 minutes to read

Red flags

  • One customer above 20% of revenue

    When one customer brings in more than a fifth of revenue, much of the value you are buying depends on a relationship you do not yet control.

    Severity: price it inCustomers and revenue

  • Contracts that end on a change of control

    Some customer, supplier and licence contracts let the other side walk away or renegotiate when the business is sold. Find them early and make consent part of the deal.

    Severity: fixableCustomers and revenue

  • The owner does the selling or holds key relationships

    When the owner wins the work and keeps the important relationships, part of the revenue may leave with them. Test how much of that revenue would stay without them before you agree a price.

    Severity: price it inOperations and people

Free tools

  • See a low, likely and high value from the figures you have, and whether the asking price holds up.

  • Answer about 15 quick questions about a listing to see which areas need checking.

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