Beware of Customer Concentration Risk

One of the biggest risks in M&A is customer concentration risk. It is hard to avoid as a business owner; if a customer is giving you orders, you generally take them! The next thing you know, your customer has 90% of your sales and they own you. We see this a lot in both the PCB and contract manufacturing industries.

The definition of customer concentration changes from buyer to buyer. Some get nervous at 20% or greater than 25%. Others worry if the top three to five customers total more than 50% of sales. Further, the largest customer may be under 10%, but 80% of the customers being in one particular sector also creates sector risk (e.g., the oil and gas industry).

In many cases, most financial buyers—such as private equity firms—will not touch deals that have concentration risk. This eliminates one of the most active parts of the M&A market at the moment. Also, many banks will not finance deals with customer concentration risk, which forces the buyer to put in more cash and reduces ROI, valuation, and terms.

However, strategic buyers may be interested in a business with high customer concentration but may put more of the deal into deferred payments. This is risky because the seller loses control of the customer relationship after closing (i.e., the buyer may lose the customer by changing policies, pricing, etc.).  A buyer may also want the owner to stay after closing for a longer period.

With a larger acquirer, a 50% customer for you might be a 5% customer for them, which represents less risk and customer due diligence. A strategic buyer may want to get a foot in the door of your major customer and think they can sell a lot more to them. In addition, the large customer may be happy that the seller is being acquired by a larger company, which reduces the customer’s supplier risk.

The longer the customer has done business with the company, the more likely something bad will happen. This is a difficult pill for many owners to swallow. Unfortunately, most distressed companies we see had one large customer that evaporated or stopped paying. It is a risk that many owners are comfortable with, but buyers are usually nervous about.

Below are some reasons why buyers and banks may be nervous about customer concentration risk: 

  1. One phone call and the business can evaporate overnight.
  2. Customers may use the sale of the company as an opportunity to look for other suppliers or change policies.
  3. Customers may get acquired or have other sources or policies.
  4. Customers may be nervous about putting so much business into one supplier.
  5. Customers may have a relationship with the owner or another key person, such as a salesperson. The relationship may change or a key employee may take that customer to a competitor once the owner is out of the picture.
  6. Customers may become distressed, start paying slowly, or go bankrupt.
  7. Customers may move business overseas.

We’ve been involved in PCB deals that had up to 80% customer concentration, and contract manufacturer (CM) deals that had up to 95%. Deals can be completed in these circumstances; however, both valuation and terms usually suffer.

It can be a difficult and time-consuming process, but here are some steps a business can take to mitigate customer concentration risk:

  1. Put resources into developing other customers and incentivize the sales team to grow new business. If internal resources are not available, engage outside representatives and distributors.
  2. Monitor the diversification efforts and make sure resources are not constantly pulled in to satisfy the top customer.
  3. Co-develop products and find opportunities for customers to invest in your business.
  4. Maintain gross margin discipline (i.e., no-bid projects that have low profitability).
  5. Be sure that the customer has multiple contact points in your company and is not reliant on one relationship.
  6. Get long-term contracts. If a customer’s expansion requires you to invest in equipment and/or more employees, try to get something in return, such as cancellation policies or make-or-take provisions.
  7. Diversify into other products and services. For a PCB shop, look into handling overseas boards or turn-key assemblies. For CMs, expand into new services for other customers or into new geographical areas.
  8. From an early stage in the company, set a limit on the amount of business represented by any one customer and set floors on gross margins.

By working to diversify the customer base, a business owner can make the company less risky, more valuable, and easier to acquire.

 

Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. He is a registered representative of StillPoint Capital, LLC—a Tampa, Florida member of FINRA and SIPC—and securities transactions are conducted through it. StillPoint Capital is not affiliated with GP Ventures.



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2018

Beware of Customer Concentration Risk

08-08-2018

One of the biggest risks in M&A is customer concentration risk. It is hard to avoid as a business owner; if a customer is giving you orders, you generally take them! The next thing you know, your customer has 90% of your sales and they own you. We see this a lot in both the PCB and contract manufacturing industries.

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Punching Out! Dealing with Family Businesses

06-28-2018

Some families may have spent this past Father’s Day discussing family business issues, including when, how or whether to pass the baton. There are several issues to consider when dealing with a family business.

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Fact or Myth: Do 80% of M&A Deals Fail?

05-09-2018

We are often asked by business owners if the commonly quoted figure is true that 80% of mergers fail to meet expectations after closing. There is a fair amount of research on large ($1 billion+), public deals that suggests that the 80% post-closing failure rate may be true.

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How to Prepare for a Smooth Post-M&A Deal Transition

04-05-2018

Selling a company is an exciting process, as well as time-consuming, stressful, and complex. Both sellers and buyers are sometimes so caught up in the deal that they forget to properly plan the post-deal integration.

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Cross Border Deals: What to Look for and How to Manage

02-22-2018

My firm has been approached by foreign firms several times this year and in 2017 who want to acquire PCB, PCBA, or other electronics companies in North America.

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Punching Out! Top 10 M&A Deal Killers

01-25-2018

I am often asked about some of the reasons why M&A deals die. Although this is a very painful subject, hopefully through sharing these reasons we can help some deals survive the M&A process. Here are my top 10 M&A deal killers (and some of the solutions).

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2017

Punching Out! Survey on State of the North American PCB M&A Market

12-29-2017

Recently, my firm surveyed about 20 PCB manufacturers in North America with an estimated greater than $10 million in revenue. Quite a few replied, and we have spoken with many others throughout the year, which gives us a good view on the state of the PCB market. If I did not contact your shop recently, it is because we already talked within the last 12 months.

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Punching Out!: PCB/PCBA M&A Top 10 FAQs

11-13-2017

We talk with owners a lot about the possible sale of their businesses. Here are the top 10 questions asked by PCB/PCBA shop owners about the process.

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Punching Out! Case Study—Lessons on a Deal

10-19-2017

This is a story of one of our clients, a U.S. contract manufacturer that sold a few years ago. To maintain confidentiality, the names have been changed and the details slightly modified.

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Punching Out! Making the Process Easy (M&A Process Engineering)

09-06-2017

In the M&A world, there are companies that make it easy (or at least easier) and those that make it difficult. By making the process easier, sellers should see better valuations and terms, and have a smoother deal process.

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Punching Out! Bridging the Valuation Gap Between Buyer and Seller

06-13-2017

PCB acquisitions in the U.S. are down so far in the first five months of 2017, with only two announced deals (HT Global Circuits’ acquisition of Pho-Tronics in April; American Standard Circuits’ acquisition of Camtech in May); and one anonymous deal that I am aware of that has not been announced. This compares with 11 announced deals in 2016. There are a variety of reasons for the decline, but one reason could certainly be the valuation gap between buyer and seller.

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Punching Out! How to Put a Wrench in the Rumor Mill During the Sale of a Company

05-23-2017

When selling a house, the owner’s agent puts a sign in the front yard, posts info on the Web, and invites buyers over for an open house. When selling a car, we put a sign on the windshield and take out an ad with our phone number on it. However, when selling a business, some owners do not even tell their spouses.

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Punching Out! Selling a Company—Seeing it as a Triumph, Not a Defeat

04-25-2017

Somehow, there is a still a stigma that selling a company is a negative for the owner. Many people think that there must be something wrong, otherwise, they would not be selling. In reality, exiting a business should be looked at as a triumph for the owner, not a defeat.

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Punching Out! 10 Ways to Increase the Value of Your PCB/PCBA Shop

03-22-2017

I have worked with a wide range of companies in the PCB, PCBA, and other tech and electronics sectors. Through the years, I have developed some ideas on how companies can improve their valuation. Some of these ideas are simple and involve little cost, other ideas are more long-term and involve more effort or investment.

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Punching Out! When Should I Call an Investment Banker?

02-20-2017

The quick answer is ASAP. Even if you are not considering the sale of the company for 5−10 years, it is best to be educated and prepared. Give your advisor (or a few advisors) a call to discuss what can be done to get the company ready for a future sale. The worst time to call an i-banker or business broker is when you are forced to sell due to poor performance, health issues, pending bankruptcy, or dispute with a partner or manager.

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Punching Out! Types of Company Buyers in the PCB and EMS Sectors

01-09-2017

Mergers and acquisitions in the U.S. PCB sector have been in the news recently, with at least 12 deals completed over the past year, and several more in the works. In contrast, the EMS sector has been relatively quiet, but that may change now that the presidential election is over.

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2016

War Stories from the Front Lines of Deal-Making

09-16-2016

Here are some war stories from my experience in working on M&A deals in the PCB, EMS, and electronics fields. The names and details have been changed to protect the innocent.

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Timing: When is the Best Time to Sell?

08-18-2016

A few of the top questions we receive relate to the timing of the sale of a business. The first is, "Is now a good time?" The second one is, "How are market conditions?" These are the top FAQs.

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The PCB Sector—What Buyers Look for and Recent Deals

07-14-2016

The past few months have seen a rash of PCB deals in North America, for a variety of reasons.

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What the Heck is Adjusted EBITDA?

06-07-2016

If you are looking to sell or buy a business, you will most likely come across the term ‘adjusted EBITDA.’ Other common terms are adjusted cash flow, owner’s discretionary earnings, earnings after add-backs, etc. What do these terms mean, and why are they important?

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The Additive Process: Tips on How to Buy a Board Shop or Assembly House

05-14-2016

One of the quickest ways to grow a business is to acquire another business. At the same time, acquiring a business can be risky, and a really bad deal may put your original business in jeopardy. Here are some tips on how to make acquisitions.

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Your Baby’s Ugly, Now Get Over it (How to Work with Buyers)

04-14-2016

Here’s a scenario: An owner has gone to market and is starting to get feedback from buyers, and shockingly, not everyone appreciates the hard work and achievements that went into the business. Buyers may not understand the business, or they may be trying to position things for a low offer. In any case, it is important to know how to work with buyers.

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Putting Together the Deal Team

03-21-2016

When preparing to sell, remember the old saying, “He who represents himself has a fool for a client.” While many owners might be tempted to go it alone, in my experience it pays to have a deal team to help prepare a company (and the owner) for a sale

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Punching Out: How to Sell Your PCB/Assembly Shop

02-04-2016

You are thinking of selling your PCB or assembly shop. Perhaps you are contemplating retirement, you have no successors, and the thought of going to the office on Monday is driving you crazy. This column is designed to help your planning efforts. Future columns will go deeper into each subject

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