How to Price, Structure, and Diligence Around Customer Concentration

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When evaluating a small business to acquire, to suggest that some form of concentration is common is likely an understatement. Indeed, in most cases, concentration of some variety is a borderline inevitability. Though this often takes the form of customer concentration (the focus of this blog post), it can take other forms as well, including key person concentration, supplier concentration, reseller concentration, and technology/platform concentration, among other forms.

Though, all else being equal, buyers would naturally prefer to purchase a business with as little concentration as possible, perhaps this reality is one reason (among many) why Search Funds have been able to acquire companies at a median multiple of 6.2x – 6.9x EBITDA between 2022-2024, in contrast to traditional middle-market private equity, where multiples averaged 11.9x in 2024, per Bain & Company’s 2025 annual Private Equity report.

The aim of this blog post is to discuss when customer concentration is acceptable (and when it is not), how to incorporate its associated risks into the transaction’s price and structure, how to diligence the likelihood of those risks manifesting, and the types of business models where the defection of large customers should be viewed as an expectation, and not as an improbable risk.

How Much is Too Much?

In isolation, it’s difficult to say how much customer concentration should be viewed as being “too much”. That said, in most transactions where customer concentration is noted as being a risk, the largest customer (or small number of customers) often represents anywhere between ~10% – 30% of total revenue.

Absent any adjustments to price or structure, concentration outside of this range (30%+) could be suggestive of a business that is simply too “easy to kill”. The same would be true of a medical practice with a single physician generating 50%+ of total billings, a software company whose entire code base was built upon a now-deprecated technology, or a distributor that sources its products entirely from a single supplier.

Though there are other variables to consider, the amount of customer concentration that buyers should be reasonably willing to accept depends largely on the transaction’s price and structure, each of which we explore below:

Price

First: At the risk of stating the obvious, a lower entry multiple allows buyers to assume risks that might otherwise be unpalatable at a higher multiple: 30% concentration with a single customer is likely hard to underwrite at an 8.0x entry multiple, but is – at the very least – more reasonable at a 4.0x multiple.  

Second: Buyers can quantify, even directionally, the likely impacts to profitability should a large customer defect, and not all situations are created equally in this regard. In some cases, depending on the profitability of the large customer in question, the “remaining” EBITDA post-defection can still produce a reasonable entry multiple, whereas in other situations, the effective entry multiple would be much less palatable.

Consider two otherwise identical companies, Company A and Company B. Both have 30% of their revenue coming from a single customer, and both are being acquired for $10M, which represents a 5.0x multiple on their $2.0M of LTM EBITDA. The only difference between the two companies is that, in Company A, their largest customer is about as profitable as their other customers (all customers generate a ~20% EBITDA margin). However, in Company B, their largest customer is less profitable than their other customers, as their largest customer produces a 10% EBITDA margin, whereas all others produce 20% margins.

(It’s worth noting that Company B’s predicament is much more common than you might suspect: Large customers are often less profitable than smaller ones, in part due to the negotiating leverage that they often attempt to exercise over their vendors).

If we acquired both companies and the largest customer defected immediately upon closing, the tables below illustrate the difference in the effective entry multiple on the EBITDA that remains in the business post-defection:

In Company A, our $10M entry price now represents a 7.1x multiple on the EBITDA that remains after the defection of our largest customer. However, in Company B, our $10M entry price now reflects just a 5.9x multiple on the EBITDA that remains. The latter may be a risk that we’re willing to assume, whereas the former may not be.

Structure

How the transaction is structured tends to be the most common (and, in some cases, the most effective) way for buyers to underwrite an otherwise high level of customer concentration, and the concept goes back to the “effective entry multiple on remaining EBITDA” discussed above.

In our previous example, the price that we paid was static at $10M (the numerator), and we were hopeful that the EBITDA remaining in the business post-defection (the denominator) was large enough to produce a palatable entry multiple. When we adjust structure, however, we’re also able to adjust the numerator to “manufacture” a multiple that we deem to be acceptable as buyers.

Consider two different offers on an otherwise identical company: In Example C, all $10M is paid to the seller upfront. In Example D, however, $2M of the $10M purchase price is deferred, and payment is contingent upon the retention of the large customer. If the customer defects within the 12 months following closing, the $2M would be forgiven.

Again, you can see the notable difference between the two transactions: In Example C (all cash upfront), our effective entry multiple post-defection rises to 7.1x. In Example D ($2M contingent payment), our entry multiple rises to only 5.7x. In the latter case, though we’re effectively buying a smaller business at a higher multiple relative to what we had originally contemplated, the transaction may still make commercial sense. In the former example where there was no structuring, the effective entry price may now be too high to consider proceeding.

Contingent consideration can take several different forms. For example: (a) A forgivable seller note where some portion of the principal balance (up to 100%) is to be forgiven if the large customer is lost; or (b) An earn-out that is paid to the seller after an agreed upon period of time if that large customer is retained

There is also some flexibility around the specific terms that govern these forms of contingent consideration. For example:

• X% of the contingent seller note will be forgiven if the revenue generated by the largest customer were to fall below its LTM value in the first 12-months after closing; or
• X% of the contingent seller note will be forgiven if the revenue generated by the largest customer (over the next 12 months) falls below its average value over each of the past 3 years; or
• A X% decrease in the revenue generated by the largest customer in the first 12 months after closing will lead to the same X% of the seller note being forgiven

Given that these are negotiated agreements, buyers are of course limited to terms that the seller deems to be commercially reasonable and acceptable. In order to make these types of structures more palatable from the perspective of the seller, buyers may have to offer them upside commensurate with the downside that they’re being asked to assume. For example: If a 30% decrease in the revenue generated by the largest customer will lead to the same 30% of the seller note being forgiven, then a 30% increase in revenue from that large customer will lead to a 30% increase in the amount of the seller note due upon its maturity.

A Third (Imperfect) Pillar of Protection: Reps and Warranties

Though price and structure are likely the best ways to protect oneself against the risks of customer concentration, there is a third option, albeit a less optimal one:

Representations and Warranties (usually referred to as “Reps & Warranties”) can be thought of as legally binding promises that the seller makes to the buyer that certain things are true (buyers also make reps & warranties to sellers, but there are usually far fewer of these). For example, the seller usually must represent (aka promise) that she didn’t intentionally misrepresent any material facts to the buyer, nor did she omit any material facts that might have reasonably impacted the buyer’s investment decision.

To further protect themselves against customer concentration risk, buyers could include within the purchase agreement certain reps and warranties specific to large customers. These could include things like:

• The customers haven’t provided notice to terminate an existing contract
• The customers have not signalled an intent not to renew, nor have they signalled a material reduction in business volume between the two companies
• None of the company’s top customers have received special pricing, rebates, or off-book concessions that are not reflected in the financial statements.

In my experience, reps & warranties should be thought of as part of a broader package of protection mechanisms. The problem with them acting as the sole source of protection is that if they ever have to be relied upon, the commercial damage to the business has likely already done, and the best that the buyer can now hope for is some sort of legal recourse.

How to Diligence Customer Concentration Risk

Not all instances of customer concentration are created equally. Buyers would be wise to spend a considerable amount of time during the commercial due diligence process coming up with a view on just how acute the risk is in their specific situation.

Below is a non-exhaustive list of variables that buyers may wish to consider:

• Per our analysis above:
  • How profitable is this large customer relative to our other customers?
  • If the large customer left, how much EBITDA would remain in the business, and what would the effective purchase multiple be on that remaining EBITDA?
    
    
• For how long have they been a customer?
  
  
• Over each of the past 3-5 years: Has this customer’s spend with the company increased, decreased, or stayed flat?
  
  
• Do any of our existing competitors offer this customer a reasonable alternative to our product or service?
  
  
• Is there a history of similar customers eventually bringing this product or service in-house once they reach a certain scale?
  
  
• Who “owns” the relationship with this customer internally? Does the relationship reside largely with the selling shareholder (who is likely to exit the business after closing)?
  
  
• Has the large customer recently undergone a leadership change (either at the C-suite level, or at a decision-maker level lower down in the organization)? Though this may not suggest a higher likelihood of defection in and of itself, in my experience new leaders often like to “put their own stamps” on the company, including in-housing or shopping around amongst competitors
  
  
• For large customers that have multiple branch locations that are themselves customers:
  • Who makes the purchase decisions? Is it a single decision that happens at the HQ level, or are purchase/renewal decisions made at each individual branch?
  • Who is the counterpart to our contract with this customer? Do we have a single contract that governs our relationship with all branch locations, or do we have individual contracts with each branch?
  • When we first acquired each of these branches as customers, was it a single sales cycle to HQ, or were there several individual cycles with each branch?
    
    
• What switching costs, if any, does this customer have? How time consuming, expensive, or disruptive would it be for them to either switch providers or bring this in-house? Below are a few variables that might be suggestive of high switching costs (and thus, a higher likelihood of stickiness):
  • The customer uses your product very frequently (daily or weekly)
  • The customer has no internal infrastructure (people, processes, or technology) that would allow them to easily in-house the product or service
  • Your product is mission critical for your customer, and any outage or disruption to your product would cause them material financial or operational harm
  • The cost of your product represents a small percentage of your customer’s total operating expenses
    
    

Though this list likely represents a decent starting point to understand just how acute the concentration risk is, unfortunately even the world’s best commercial due diligence process can still under-estimate the likelihood of a large customer defecting. In my experience, this unfortunate reality is particularly true in a very specific type of business model, which brings me to my final point:

Beware: Outsourced Business Services

Although many Search Funds explicitly target Outsourced Business Services companies (often for good reason), I have observed that large, long-tenured customers often present a particularly acute defection risk after a certain period of time.

This is usually because when the customer first made the decision to outsource the service in question (often 5, 10, or even 15 years ago), it made perfect sense for them to do so at their then-current scale. However, as that customer grows over the course of many years, outsourcing becomes less and less optimal for them, and at a certain scale, it makes much more sense to in-house the service in question.

Two illustrative examples that tend to be particularly common targets among Search Funds are outsourced bookkeeping providers and Managed Service Providers (“MSPs”, effectively outsourced IT management). While it may have made perfect sense to outsource these types of services at $5M of revenue and 20 employees, it often makes considerably less sense at $50M of revenue and 200 employees. This isn’t to say that growth is a guarantee of defection, but all else being equal it at least makes it more likely.

In this way, then, a long-tenured relationship with a large customer isn’t necessarily always a good thing. Especially so if your target company operates within a model that makes it more likely for large customers to eventually “outgrow” the service in question once they achieve a certain level of scale.

In Sum

All else being equal, nobody will be surprised to hear that buyers prefer to purchase companies with as little concentration as possible. However, any small business investor or operator can tell you that concentration – of some variety – is so common as to be almost expected.

No transaction is free from risk, but my hope is that the considerations that we’ve discussed above will help you come to an informed view of whether the risks that you’ll be assuming as the buyer are ones that you’re willing to bear.

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