Does a diverse customer base enhance the value of your company?

By Generational Equity

08/16/2016

Are you aware of the key factors that impact your company’s value? Often, these are clear to see. These include projected cash flows, the reputation of your business, the value of your assets and the general outlook for your industry. A combination of these elements will positively or negatively impact your business valuation when the time comes to take it to market.

However, other aspects are not quite as obvious, yet can be instrumental in establishing your company’s overall value. One of these is the diversity of a company’s customer base. Of course, many companies are proud of the long-term relationship they have established with a respected client. This can be an important factor in getting your start-up company off the ground.

But, from that moment on, it is important to diversify. Late last year, a report published by the Business Development Bank of Canada (BDC) highlighted the significance a diverse customer base has on your overall business valuation. Their survey of nearly 1,000 Alberta SMEs brought attention to important details that all business owners should be aware of:

• 7 out of 10 diversified firms achieved high revenue and profit growth in the past three years, compared to 2 out of 10 with customer concentration issues
• Low reliance on a particular customer is the biggest predictor of whether firms are confident about their prospects for the next 12 months
• Small and mid-sized businesses that are diversified in more than two ways (customer, products, services, location of operations) are far more likely to attain strong financial success

A startling statistic from the BDC’s report is that 62% of the Alberta businesses surveyed said they do not rely on a single customer for their revenue. This indicates that close to 38% of Alberta companies have customer concentration issues, which could prove problematic to many potential buyers.

Take for example the case of Celestica in 2013. The Toronto-based electronics manufacturing company had annual revenue of US$6.5 billion in 2012. However, Smartphone constructors Blackberry generated approximately 20% of this. When they were forced to end their relationship due to their own cost-cutting measures, Celestica’s first-quarter results were down 19%, forcing the business to reinvent itself in recent years in a bid to rebuild.

Consider this scenario: You wish to place your Vancouver-based manufacturing company on the market, buoyed by a compound annual growth of 20% over the past five years, improving profit margins and an annual revenue of C$18 million. However, a professional buyer has been alerted by the fact a single customer is responsible for 28% of this annual revenue.

Investors will likely be concerned by this overreliance on a sole client. They would consequently be more likely to shift their interests toward a similar business with a broader customer base, as it represents a greatly reduced risk (and buyers hate risk). While total revenue and consistent growth are important, they can be significantly impacted by the hazards associated with relying on a single source for revenue.

This scenario also makes it difficult to convince investors that the relationship with this prominent client is not predicated on their connection with the current owners. This would be viewed as a sizeable risk factor to many buyers; what if the customer was to cut back on orders following the change of ownership? Clearly, the revenue of the company will inevitably suffer.

There is a solution to this problem. It is crucial to never allow your company to become complacent in its marketing and sales efforts. As time goes on, you can find yourself dependent on the income generated from this single source, placing your future earnings at risk from the perspective of a potential buyer.

Therefore, when you decide the time is right to sell your small business, you should conduct a thorough review of your client list. If you find that your company has become reliant on a single stream of revenue, it is important to identify and pursue additional sources before your business is ready for market.

In short, business owners cannot afford to rest when it comes to their sales and marketing efforts. Continue to expand your base, seek out new sources of revenue and diversify every aspect of your business. Following these steps may boost your company’s market value and enhance its sale-ability.