One of the keys to success is to surround yourself with smart people. Although I am not saying that I am successful, our firm has been in existence for over thirty-eight years and I have been blessed to have many great and talented team members. I mention this because one of my current team members, Scott Densmore, authored this month’s feature article and I encourage you to play the accompanying video.
Concentration is not always about mental focus. Here, we are referring to Customer Concentration, Product Concentration, and Supplier Concentration. The higher the concentration, the higher the risk there is that your business will not continue to produce consistent cash flow. They say Risk equals Reward, but really only successful risk-taking leads to reward. In the case of a business sale, a risky business equals potential reward for the buyer, not the seller, because the buyer is the one taking the risk. So how does the buyer receive this reward? … Lower purchase price. The riskier the business, or in other words, the lower the likelihood that the cash flow will continue, the lower the purchase price you can expect to receive.
Here are three areas to address that may help you maximize the value of your business:
There are businesses with only one client and other businesses where their top customer is only a fraction of a percent of annual gross sales. Which one do you think has a lower risk of losing all their cash flow overnight? The exact levels of proper customer concentration is a point of debate, but it is generally accepted that if your #1 client is more than 10% of your annual revenue, then you have a customer concentration issue. Does this mean that you cannot sell a business with only a single client? No, not necessarily. However, a company with little to no customer concentration issues should be more appealing to more people and therefore bring more money when they go to market. If you have a customer representing 10% of your sales, there is no need to worry, just focus on growing the business and diversifying your customer base.
The 10% rule can also apply to your products or services. If you sell one specific widget, your business is at a much higher risk than a business that has 10, 20, or 100 different SKUs. The same idea that makes it dangerous to have one client that could disappear without notice, applies to having only one product that may drop out of favor with consumers. While some may view Product Concentration as less of a risk than Customer Concentration, it should still be on your radar.
Are you too heavily reliant on one supplier? What if they disappeared overnight? What would happen to your business? Many companies experienced this dilemma when the COVID-19 shutdowns first hit. Manufacturers in Colorado banded together, sharing supplier information, attempting to find new suppliers here in the U.S. and even more locally when possible. Although it was great to see the teamwork that helped get many people through the turmoil, the best positioned businesses already had a diversified pool of suppliers … providing multiple options for everything that they need to run their business. If one supplier controls your ability to make sales, then they control your livelihood … that is a high risk that needs to be addressed.
(originally published in the September 2020 eNewsletter)