What is the Value of My Business? Concentration Risks
Published by
Brian Breneman
on
Two seemingly identical businesses can have vastly different values due to concentrations.
Concentrations are a form of risk that can significantly impact the return investors or buyers expect on their funds. Buyers and investors frown upon concentrations because of the size of the negative impact. If a business has 50% of its sales from a single customer and then loses that customer, the impact can be severe.
What Are Concentrations?
Concentrations refer to the over-reliance on a specific factor within a business. These can include:
- Industry Concentration
The end market industry for your products is what drives an industry concentration. Consider a company that supplies the auto industry versus one that supplies the food industry. The auto industry is cyclical, with distinct ups and downs. Conversely, the food industry experiences consistent demand since people must continue to eat. As a result, businesses that supply the auto industry face higher risk and generally lower valuations than those in the food industry. - Customer Concentration
Customer concentration occurs when a business relies heavily on one or a few major customers. If one of these customers leaves, the financial impact can be substantial. Conversely, a business with a broad customer base where no single customer contributes more than 1-3% of revenue is more resilient, with minimal impact from losing one account. - Vendor Concentration
Vendor concentration is when a company depends on a limited number of suppliers. This creates potential risks tied to supply chain disruption and pricing of product. Vendors may be local, national, or international, with overseas vendors adding additional geopolitical risk. - Employee Concentration
Employee concentration occurs when a company’s workforce heavily relies on a specific demographic or skill set. This can create vulnerability if changes in that workforce reduce its cost or effectiveness. A good example of this is a union workforce. Unions offer training and labor supply advantages, but the risks of labor contract negotiations and potential strikes offset them. Another more common example is family employees, which can be affected by personal relationships. - Management Concentration
If a company lacks depth in its management team, losing a key manager can be devastating and costly. Concentrating a number of functional duties on an individual can also add risk. Strong management has depth, solid training, and succession plans. - Geographic Concentration
A business operating in a limited geographic area faces risks associated with local economic conditions and limited growth opportunities. This type of concentration can be related to the availability of labor pools or customers if the business offers services. A service business with a limited population density will have a discount due to geographic concentration that limits growth opportunities.
Mitigating Concentration Risk
Concentrations can negatively affect a business' value by 10% or more. We have many examples of this and continue to study the differences between similar-looking businesses. There are many strategies to reduce concentration risk and enhance business value. By diversifying customers, suppliers, and geographic markets and building depth in management and workforce, businesses can improve their stability and long-term growth prospects. Addressing these risks is often straightforward yet impactful, and implementing such changes can significantly improve a company’s value.
Ready to uncover the hidden risks impacting your business value?
Don’t let concentration risk diminish your hard-earned equity. Our team specializes in helping businesses like yours identify and mitigate value drivers that buyers scrutinize most. Let’s talk about how you can protect—and grow—your company’s value.