16 December 2024: Selling a Business:
“Owner Concentration?”
“Owner concentration”?!? What the heck is owner concentration?
We’ve occasionally discussed client or customer concentration in various articles on this blog and we spend some time on that topic in our courses – especially in the valuation modules. But we rarely tackle the phenomenon of “owner concentration, mainly because it’s not something we see very often.
WHAT WE’RE LOOKING FOR: Small Industrial Companies: Industrial services Including industrial maintenance services, heavy equipment repair Revenue: >$2M; EBITDA: >$1M. U.S.–based
in**@Wo**********************.com
But owner concentration exists and if you’re selling a business – as the owner or the broker – it’s pretty important that you recognize it and understand what it means to the business’ value.
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Client or customer concentration refers to a condition where one or two clients or customers account for a large percentage of the business’ revenue. We don’t like to see one customer being responsible for more than 20% of a business’ revenue; even 10% makes us a little uneasy. When selling a business, the concern, of course – ours and any buyer’s – is that, should such a large customer have a change of heart, sales will fall significant and, as night follows day, earnings and value will follow it down.
Owner concentration is essentially the same, only in reverse. If the owner of the business is personally responsible for a significant portion of the business’ revenue, the concern – ours and any buyer’s – will be that, once the owner is out on the driving range or island hopping with B-list celebs on a handsomely appointed 60′ Beneteau Oceanis, sales might end up in the toilet.
Small business owners are generally the “face” of their business. They built that business from the ground up (notwithstanding the claims of a certain past U.S. president) and much of that early success can be chalked up to personal relationships and personal service. A change in that dynamic can quickly unnerve long-time clients and customers – and selling a business certainly qualifies as major dynamic!
We’re working on a situation very much like that right now.
In this case, our client runs a service business with two employees and five independent contractors that work exclusively for our client’s business. Over the past four years, the business has averaged roughly $2 million in annual revenue. The owner started the business about 20 years ago and it is now, and, with the exception of one or two years when national economic conditions hindered it, has been since early on highly profitable. Our team valued the business at about $1.350 million, based solely on the financial information provided by the business’ outside accountants.
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Courses! Courses! Courses!
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We’ve broken our Flagship into six separate modules (or module groups) to give you all the flexibility you need to learn only what you want to learn – and we’ve moved them all over to the new Brokers Academy in The Brokers Roundtable℠ . The Flagship is still available but the modules are now available individually.
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But, of course, this is where the hard work comes in. What else impacts value? There are many other factors, to be sure, including:
- Is the industry expanding or contracting?
- The business’ target demographic: growing or declining?
- The geographic location of the business; will it appeal to a large pool of buyers?
- The legal environment for what the business does/provides
- The availability of financing and the willingness of the seller to participate in financing.
- Customer concentration
One of these additional factors is “owner concentration”. This is the issue we face in this instance.
We suspected fairly early in the process that the business’ owner was responsible for the lion’s share of the revenue and on several occasions requested an estimate from the owner of what percentage of sales he would attribute to his own efforts. The fact that we’ve yet to receive such estimate, our concerns about this have only grown and we’ve begun preparing for the inevitable client conversation about how customer concentration is likely to impact the “sell-ability” of the business.
As with almost all problematic businesses, there are a couple of owner options but most of them are, to one degree or another, unappealing to someone with the vision of living life in an Italian vineyard for a couple of years post-closing.
One option is to prepare to discount the price and acknowledge to any serious potential buyers the reason for this. Another is to prepare for an extended transition period during which the seller stays on with the business as sales are gradually taken over by the new owner or existing member of the team. A third option is, similar to option 2, structuring the sale as an earn-out in which the ultimate price the buyer pays is determined by the performance of the business during a defined, multiple-year period after transferring ownership.
Both Option 2 and Option 3 require the seller to plan for an extended stay in operating the business.
The Bottom Line
Owner concentration, though not as prevalent as customer or client concentration, can have similar negative impacts when selling a business, particularly on the ability to sell that business at a value the financials would suggest the business is worth. This is always an uncomfortable conversation to have with a client but one that must happen and is part of our oft-mentioned topic, “Managing the Client’s Expectations“.
Selling a business ain’t for sissies and bringing a business to market with a price expectation that ignores this negative aspect of the business will likely result in an enormous waste of time and, in the broker’s case, efforts and money.
I’d like to hear from you. What topics would you like me to cover? How can we tailor these posts to be more useful to you and your business. Let me know in the comments box, below, or email me at
jo*@Wo*******************.com
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If you have any questions or comments on this topic – or any topic related to business – I’d like to hear from you. Put them in the comments box below. Start the conversation and I’ll get back to you with answers or my own comments. If I get enough on one topic, I’ll address them in a future post or podcast.
I’ll be back with you again next Monday. In the meantime, I hope you have a safe and profitable week.
Joe
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The author is the founder, in 2001, of Worldwide Business Brokers and holds a certification from the International Business Brokers Association (IBBA) as a Certified Business Intermediary (CBI) of which there are fewer than 600 in the world. He can be reached at
jo*@Wo*******************.com