Does customer concentration lower my valuation?
The direction is well evidenced and the size of the effect is not. Concentration raises a buyer's cost of capital and reduces the number of bidders, which is where the money goes.
Almost certainly, but not by an amount anyone has measured. The direction is supported by peer-reviewed research. The specific figures you will read elsewhere, usually "a full turn on the multiple," have no published source that we have been able to find.
What the evidence actually shows
| Finding | Source | What it means for your sale |
|---|---|---|
| Concentration raises the cost of equity and of debt | Dhaliwal et al., 2016 | A buyer's model discounts your cash flows harder |
| It raises loan spreads and shortens maturities | Campello & Gao, 2017 | A buyer's financing is more expensive |
| Acquirers place fewer bids for concentrated targets | Cheng et al., 2022 | Less competition, which is what sets price |
| Acquirers use more stock payment | Cheng et al., 2022 | You carry risk after the sale instead of banking cash |
The third row is probably where the money goes. In a private sale, price is set by competition far more than by any single buyer's discount rate. Fewer bidders is worse than a larger discount from one of them.
All three studies are on listed companies. The mechanism is not exotic and very likely carries over to a business your size, but nobody has measured it there.
Why an earn-out rather than a discount
Because the buyer cannot price the risk, they transfer it. That is consistent with the research finding that acquirers shift towards stock payment for concentrated targets: when a risk cannot be underwritten, it gets moved rather than discounted. An earn-out ties part of your consideration to the customer still being there in two years, which converts a price you agreed into a price you have to earn.
What actually helps
- Grow the rest of the business — you cannot fix concentration by losing the customer
- Get the relationship contracted, with a notice period and a renewal date well after completion
- Move the relationship off yourself and onto someone who stays
- Show the customer's own tenure — eleven years of history reads differently from two
- Know your concentration by profit as well as by revenue; the two rankings differ
Every one of these reduces the probability or the consequence of losing the customer, which is the thing a buyer is actually pricing. None of them works in a final quarter, which is why concentration belongs at the start of a preparation plan.
There is a second side worth knowing. Research on listed suppliers also finds customer concentration associated with higher accounting returns, through lower operating costs per unit of sales. Concentration buys efficiency while it sells financing flexibility. A buyer who only sees one side of that trade is mispricing your business in a direction you can argue about.
What the evidence actually says about customer concentration goes through the research in full, including the figures we could not verify and have not used.
Sources
- Dhaliwal, Judd, Serfling and Shaikh, "Customer concentration risk and the cost of equity capital," Journal of Accounting and Economics 61(1), 2016. https://econpapers.repec.org/RePEc:eee:jaecon:v:61:y:2016:i:1:p:23-48
- Campello and Gao, "Customer concentration and loan contract terms," Journal of Financial Economics 123(1), 2017. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2442314
- Cheng, Jaggi and Young, "Customer concentration of targets in mergers and acquisitions," Journal of Business Finance & Accounting 49(7–8), 2022. https://onlinelibrary.wiley.com/doi/10.1111/jbfa.12587
- Patatoukas, "Customer-Base Concentration: Implications for Firm Performance and Capital Markets," The Accounting Review 87(2), 2012. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1666497