Customer Concentration Risk: Lessons from a Failed Acquisition
Chris Barrett
Introduction
When buying a small business, financial red flags aren’t always obvious. Though commonly overlooked, customer concentration risk is one of the most dangerous red flags. We recently worked on a deal where the seller claimed their largest customer only accounted for 20% of revenue. But after a deeper dive in the quality of earnings (QoE) process, we uncovered that the real figure was over 60%. That discovery ultimately killed the deal.
In this post, we’ll break down what customer concentration risk is, how it can hide in plain sight, how we uncovered the truth, and most importantly, how to mitigate this risk whether you’re buying or selling a business.
What is Customer Concentration Risk?
Customer concentration risk occurs when a large portion of a business’s revenue comes from one or a few customers. This creates a fragile foundation: if one of those major customers leaves, it can devastate the company’s cash flow and stability.
Why is this a problem?
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Revenue vulnerability: Losing one client can wipe out a significant chunk of income.
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Decreased business valuation: Buyers and investors often apply discounts when revenue is heavily concentrated.
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Power imbalance: Large customers may demand better terms or renegotiate pricing, knowing their importance.
Red flag benchmarks:
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One customer >15–20% of revenue
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Top 3 customers >30%
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Top 5 customers >50%
If you’re seeing numbers like these, it’s time to investigate further.
Why It Matters in Business Acquisitions
In any business acquisition, especially of small and mid-sized companies, customer concentration is a critical risk factor that can significantly impact the value, viability, and future stability of the business. Buyers are typically looking for companies with diversified, reliable revenue streams. When too much of that revenue is tied to a single customer, the buyer is exposed to a disproportionate level of risk. If that key customer walks away post-acquisition, the financial health of the newly acquired company could rapidly decline, potentially beyond recovery.
This risk was clearly illustrated in a recent deal we worked on. The seller initially reported that their largest customer made up about 20% of the company’s revenue, a figure that appeared to be within acceptable limits. However, during the quality of earnings (QoE) process, we discovered that the seller owned two closely linked entities that were transacting heavily with one another. These inter-company transactions inflated both revenue and expenses, making it appear that customer concentration was relatively low. Once we stripped out those internal sales and recalculated the figures, it became clear that one external customer actually represented more than 60% of the business’s real revenue. That level of dependency introduced a major risk that the buyer had not anticipated and ultimately led to the collapse of the deal.
This scenario demonstrates why thorough due diligence, particularly a robust QoE analysis, is essential in any acquisition. Without it, buyers may unknowingly inherit risks that could jeopardize their investment.
Case Study: How We Uncovered the Risk
In our recent deal:
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The seller’s businesses transacted internally, inflating total revenue.
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The largest external customer’s revenue stayed constant—but as a percentage of the bloated total, it seemed smaller.
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Our QoE team adjusted for these inter-company transactions, reducing reported revenue to its actual level.
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The top customer’s share jumped from 20% to over 60%.
This single discovery shifted the buyer’s risk profile dramatically and ultimately stopped the transaction.
Key takeaway: Without independent analysis, you may never uncover this kind of risk.
How Mitigation Affects Business Value
Customer concentration risk has a direct and measurable impact on a business’s valuation. When revenue is overly reliant on one or a few customers, buyers and investors often apply significant discounts to account for the heightened risk. A company with diversified revenue streams, on the other hand, is viewed as more stable and resilient, which increases its appeal and market value. For sellers, addressing concentration issues before going to market can lead to a higher multiple and attract a broader pool of qualified buyers. For buyers, proactively identifying and mitigating this risk during due diligence ensures they pay a fair price and avoid inheriting unstable revenue. Ultimately, customer concentration isn’t just a financial metric: it’s a strategic factor that shapes deal terms, financing potential, and long-term success.
Conclusion
Customer concentration risk is a silent deal killer, and in small business acquisitions, it’s more common than you think. In our case, the risk was buried under complex inter-company accounting and wasn’t visible at first glance. Thanks to a detailed quality of earnings review, the truth emerged, and a bad deal was avoided.
If you’re buying or selling a business, don’t rely on surface numbers. Do the work. Ask the questions. And if you need help spotting risks like this before you sign on the dotted line, reach out to our team at Midwest CPA. We help buyers avoid bad deals and businesses, and grow the right one.
Disclaimer
The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting, or investment advice. You should consult a qualified legal or tax professional regarding your specific situation.
Frequently Asked Questions About Customer Concentration Risk
QoE helps verify the accuracy of reported revenue and identifies hidden red flags like inter-company transactions.
Ideally, no single customer should represent more than 15–20% of total revenue.
Only if backed by long-term, legally binding contracts with strong clients. Even then, diversification is healthier.
