The Customer Concentration Question I Wish Buyers Asked Sooner

This post is for informational purposes only. I am not an attorney. Consult your own advisors for your specific situation.

In the last month I have had three separate clients bring me deals where one customer represented more than a third of the business's revenue. All three buyers were well into diligence. None of the three knew it was a financing issue. They had been focused on the quality of earnings, the add-backs, and the purchase price, and the concentration question never came up until I raised it.

This is one of the most common patterns I see. We have reviewed over 1,500 business acquisitions in the last three years, and customer concentration is one of the four issues that kills deals most often, alongside debt service coverage, seller note structure, and add-backs that do not survive underwriting. The frustrating part is that unlike the other three, concentration is visible in about five minutes if you know to ask for the right report. Most buyers do not.

Let me try to explain how lenders actually look at this, what the real thresholds are, and what can be done when the number is high.

From a lending perspective, the logic is straightforward. The bank is underwriting the business's future cash flow, because that cash flow is what repays the loan. If a single customer generates 40% of revenue and that customer has no contractual obligation to stay after the ownership change, the bank is effectively betting a large portion of its repayment on a relationship the new owner has not yet built. Banks do not like that bet.

It is important to note that this is generally a bank credit decision, not an SBA program parameter. The SBA Standard Operating Procedure ("SOP") does not publish a customer concentration limit. Each lender sets its own internal threshold, which means the same deal can be declined at one institution and approved at another based purely on lender fit. We see this constantly across our 500+ funding partners.

Generally speaking, here is how the conversation goes inside the lender network we work with. These are internal credit guidelines, not published rules, and they vary by institution, which is exactly why lender matching matters.

The customer concentration issue can become even more profound if there are multiple customers with a high level of concentration. If the top 2 customers represent 30% of the transaction each, or 60% in total, that provides another concentration risk that lenders will want to mitigate. Most lenders look to see what percentage of revenues the top 5 customers make up, and most lenders would prefer to see that concentration at or below 50% of revenues.

Just because there is a higher level of customer concentration does not mean a deal cannot get done. We closed a deal a couple of years ago where two customers combined accounted for 95% of the revenue. However, both of those customers had been with the company for over 40 years, the company produced hundreds of SKUs for each customer that would not be easy to move elsewhere, and the company was constantly quoting new products. Because of that we were able to get lenders comfortable with the customer concentration. But that is not always the case.

The reason concentration kills deals is three fold. First, it threatens the debt service coverage ratio, not today's DSCR, but the projected one. A lender stress-testing the loss of a 40% customer will often find the remaining cash flow cannot service the debt, and the deal fails the test. Secondarily, concentration is usually paired with relationship risk: in many small businesses, the large account belongs to the seller personally, not to the company. Lastly, it constrains the exit. A bank knows that if it ever has to liquidate, a business dependent on one customer is worth far less than its purchase price.

Here is the part that even experienced buyers miss. Concentration by revenue and concentration by profit are not the same number, and the second one is the one that matters.

I have seen businesses where the largest customer was 15% of revenue, comfortably under every threshold, but closer to half of gross profit, because that account carried premium pricing while the rest of the book was low-margin volume work. A buyer who measures only revenue concentration walks into that deal blind. There is a well-documented acquisition case in the search community where a departing employee took a customer representing roughly 10 to 15% of revenue but approximately half of earnings, and the business never recovered. The revenue number said "safe." The profit number said otherwise.

That being said, a high concentration number is not automatically the end of the deal. We have had some success getting concentrated deals approved, including deals well above the comfort thresholds, when the structure directly addresses the lender's specific fear. The fear is always the same: the customer leaves, the cash flow goes with them, the loan defaults. Every mitigation below works by keeping someone else's money at risk alongside the bank's.

In addition, lender selection does real work here. Some lenders in our network have industry-specific comfort with concentration, a contract manufacturer serving two OEMs looks normal to a lender who knows that industry and terrifying to one who does not. This is why we match deals to lenders rather than submitting broadly. Our 95%+ term sheet to approval success rate is not because our deals are easy. It is because they go to the right desk first.

I have to volunteer my conflict of interest here, as I always do. CLX earns a success fee when deals close. I have a financial incentive to encourage you to move forward, and an incentive to find structures that get concentrated deals approved. I am naming that so you can weigh what follows accordingly. Truthfully, the concentration conversation is one where my honest advice is most often "do not do this deal as priced," because a deal that closes and then loses its anchor customer does not help you, and it does not help me either.

First, the hardest truth: do not sign an LOI before you have seen customer-level revenue and gross profit data. Every week I talk to a buyer who is $20,000 into diligence on a deal that a five-minute concentration check would have repriced or killed in the first conversation. The sequence matters. Concentration analysis belongs before the LOI, not in month three. If the seller refuses to provide the concentration numbers pre-LOI, be sure you get it and review it immediately post-LOI before you start spending serious due diligence dollars.

Secondarily, the strategic play: if the number is high, lead with structure, not hope. Go to the seller with a specific proposal, a larger note on full standby, an assignable contract, an earnout tied to the account, before the lender forces the conversation on worse terms. A seller who believes in their customer relationships should have no objection to standing behind them. A seller who refuses is telling you something.

Lastly, the reassurance: concentrated deals do close. We have gotten deals approved above every threshold in the table when the structure was right and the lender was right. So long as you measure the risk early and price it honestly, concentration is a solvable problem, it is the surprise version of it, discovered in underwriting, that kills deals.

If your target's largest customer is over 15% of revenue, or the top 5 customers are over 50% of revenue, you do not have a dead deal. You have a structuring problem, and structuring problems have solutions. Get the customer-level data, run the numbers by profit and not just revenue, and build the mitigation into your offer. I hope this helps.

If you have questions about customer concentration in your acquisition, we would be happy to help you find the right answer for your specific situation. We offer a free review of deals, including a concentration and DSCR analysis, before you sign the LOI.

You can reach our team directly at info@commerciallendingx.com or by phone at 888-975-0007.

— Brad Hettich, President
Commercial Lending X