The following are a few non-financial due-diligence considerations a business buyer must account for:
Establish Customer Concentration
An important element of business due-diligence is to determine customer concentration. Customer concentration may be defined as the percentage of revenues coming from a single customer. For example, a business may have five large customers responsible for 60% of its revenue.
Customer concentration is directly correlated with the purchase price and the cash at close component of the deal structure. Let’s say there are two similar companies with equal revenues, margins and net income. The business with lower customer concentration will demand higher price and higher cash at close as compared to a business with lower customer concentration. A business buyer should always model the business losing a few customers when ownership changes. If customer concentration is high, losing large customers when the business changes hands can hurt the business significantly.
When a business changes hands the former business owner still has a relationship with all customers. This relationship becomes a critical element of the due-diligence process if the customer concentration for the business is high. It is possible that after selling a business the former owner may restart the same business in the same area. The business buyer can protect himself from such behavior through non-compete agreements. If the former business owner could be a competitive threat, the business buyer must work with his lawyer to draft a non-compete agreement and get it signed as a part of the deal.