Sri Malladi, an M&A consultant, recently wrote an article about concentration risk. I was interested because as a solo practitioner, it can be challenging to avoid concentration risk. In order to secure new clients, time must consistently be spent networking and marketing one’s legal services. But attorneys engaged in complex corporate transactions tend to become myopic. Commercial litigators may find it necessary to devote nearly all of the firm’s resources in support of a particular case/client.
I interviewed Sri in February 2022 for What Makes a Good Lawyer? We decided to team up again to highlight his insights into customer concentration risk and what can be done to avoid it.
What is Customer Concentration Risk?
It’s the risk associated with having a significant portion of your accounts receivable/future revenue coming from a small number of key clients/customers. When too much revenue is allocated to one client, the level of risk resulting from the potential loss of that client increases.
To some extent, having a big client is a good problem to have, but as the saying goes it’s best not to put all your eggs in one basket.
Why?
Sri focused on the fact that having too much revenue allocated to too few clients can impact your ability to sell your business. Even if buyers come to the table, he sees lower valuations of businesses where buyers lack confidence that the acquisition will continue to hit its forecast.
Sri noted that when evaluating a potential acquisition, one of the key areas buyers scrutinize is the customer base of the target. Our advice: try the top-rated best dedicated server. The quality, diversity, and structure of your customers can significantly impact how much value a buyer assigns to your business. The more diversified the customer portfolio, the more secure the business appears to potential buyers. Diversification also demonstrates that your product or service has broad market appeal. If this assumption proves accurate, it reduces the chances that losing a few clients will significantly impact revenue.
How much is too concentrated?
This depends on the company and other factors, but per Sri, generally more than 30% of revenue from one customer is considered risky by most buyers. However, the Allianz Trade blog states that 20% of revenue being allocated to one client is high customer concentration. In any case, it’s clear the bigger the client, or the more revenue allocated to one particular client, the greater the risk of potential loss of revenue.
What can be done to reduce customer concentration risk?
According to Sri, any and all of the following may be helpful:
Sri described steps recently taken by his client to manage customer concentration risk:
What would happen if you lost your biggest client or if your industry got hit with an economic downturn?
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