How Customer Concentration Kills Value (and What to Do About It) 

I’ve witnessed firsthand that most business owners don’t understand how their customer mix is being priced until a buyer’s diligence team flags it. By that point, what buyers perceive as excess customer concentration – too much business revenue coming from too few sources – has done its damage, and the only solution is to eat an inevitable reduction in sale price. 

Thankfully, customer concentration is a quantifiable, fixable risk. In many cases where we’ve identified these issues, owners were able to turn the problems around in a way that gave buyers the confidence to make a strong offer.  

The trick is to learn what to do to mitigate the value-killing effects of excess concentration and put in the time and effort to get to a viable solution. 

Below are my thoughts on how entrepreneurs can turn around excess customer concentration risk. 

How buyers actually price concentration risk 

Not all revenue is created equal, or equally safe.  

What do I mean? Certain types of revenue, like regularly recurring revenue, are preferable to buyers because they lower the risk of shortfalls. But even in businesses without recurring models, it’s best to spread revenue across many customers and avoid concentrating in a few.  

Think of what happens to a table when a leg is removed. If one of those significant customers were to go out of business or pull their contract, it could immediately destabilize a business that relies too heavily on that customer for income.  

In practice, I often see an informal “10% rule.” Any customer representing more than 10% of revenue will draw extra scrutiny from buyers during the due diligence process. A series of 11% customers doesn’t necessarily mean buyers will try to renegotiate the purchase price or your EBITDA multiple (that depends on the buyer). But if a potential buyer sees anything in the realm of 20–25%, it will almost certainly affect the process.   

Strategic buyers tend to be more tolerant of this risk if the concentrated customer is a relationship they want access to (e.g., someone in an attractive channel they don’t currently have). Private equity platform buyers tend to be much more risk averse when it comes to concentration because their goal is to grow an asset quickly once acquired, and concentration signals potential instability. 

Structures that buyers use to hedge against risk 

These days, I see many more deals structured to offset risks like customer concentration than in previous years. One such common mechanism is an earnout, in which sellers agree to receive less cash at closing in exchange for payouts in coming years if the company continues to hit certain performance benchmarks.  

Earnouts are especially common and aggressive when concentration is present. Often, earnout terms get tied to certain key customer accounts being retained. If that customer leaves, the seller’s earnout might be lessened or zeroed out for that period.  

Another hedging structure is a holdback or escrow, which is money from the agreed-upon purchase price that’s held in reserve. If a customer leaves, the new owner may be able to draw on the escrow to cover revenue gaps if they can prove the seller knew about problems in the relationship (i.e., a breach of representations). 

The tradeoff of these structures for sellers is that to get their deals across the line, they must accept less money upfront, with the remainder possibly contingent on customer retention. 

Building a more diversified customer base before going to market 

What can you realistically do to extend your revenue reach before undergoing an M&A process? If you have at least two years, there are a few practical levers you can pull; it’s tough to diversify your revenue in the final year alone. 

Here are a few ways I’ve seen owners attack this problem: 

• Add sales capacity. Beef up your business development team and set them to hunting new accounts. Prioritize logo count over ticket size in the near term. For concentration-reduction purposes specifically, 10 new mid-sized customers improve the percentage math more than one new large account. Be sure your sales processes are well documented so everyone’s on the same page, even recently onboarded employees.  

• Expand within adjacent verticals. Pivot to sell an existing product or service into a vertical adjacent to a concentrated customer’s industry, one where the sales motion, technical requirements, and value proposition largely transfer. This may be a related sub-sector of the customer’s industry. 

• Reduce reliance on founder-led relationships. This isn’t necessarily about diversifying your revenue so much as de-risking important customer relationships. Introduce an account manager or client success lead who takes over day-to-day contact well before the company hits the M&A market. Ideally you can do this early enough that the customer develops a working relationship with that person independent of the owner. 

• Track concentration as a KPI. You already track revenue, so it’s easy enough to mind the shares of revenue coming from each customer and set goals for reducing dangerous concentrations.  

Understand that contract structure can matter as much as customer count. Multi-year agreements and diversified terms reduce perceived risk even with ostensibly concentrated customers.  

Get ahead of the risk 

Reducing concentration is one of the most powerful actions you can take ahead of an M&A market debut. The whole process is about building resilience into your business model, which buyers will pay for. It’s not about abandoning good customers who’ve had your back since the early days. 

As I recommend as a way to head off most potential M&A problems, engage an advisor early enough that concentration is less of an issue by the time buyers are digging into your documents. Getting solid guidance could add millions by the time your deal closes!