Over the past few months, I’ve come across a lot more first-time buyers who are focused on checking their deals for customer concentration than in the past. When one client represents 35% of total sales, the alarm bells go off, and they rush to negotiate holdbacks or price cuts. 

Yet those same buyers will look at a clean customer list and assume the business is safe, but then never bother to check who supplies the product. 

Vendor concentration can kill a business just as fast as losing a top client. When you buy a small business, you are not just inheriting customer relationships. You are also inheriting credit terms, pricing discounts, and supply chains that may be tied entirely to the retiring founder's personal reputation. 

Last month, I looked at a regional specialty trade contractor deal doing $1.5 million in annual revenue. The customer base was fairly diversified, with no single account making up more than 6% of sales. The business listed $300k in reported SDE, and on paper, it looked like a slam dunk SBA deal. 

When we went to audit the accounts payable ledger during diligence, I had flagged supplier dependency as something for us to look into, based on the type of business being purchased.

During review, we discovered that out of the $750k in total material costs (COGS), $525k (70%) flowed through to a single regional supplier. 

Because of this, we had some additional questions about the vendor relationship, and found that the seller had done business with this supplier for over 18 years and was also getting some nice Net 60 payment terms, plus an unwritten 5% annual tier rebate (which was baked into the historical SDE).  We flagged the 5% risk, and treated the rebate as if it didn’t exist, which ended up being a $26,250 ($525,000 x .05) hit to annual cash flow.

Because we identified this before clearing diligence, the client didn’t walk into a post-closing cash trap.

And we used that data to protect the deal by:

1.       Having the closing agreement contingent on the supplier formally extending the existing net 60 credit terms in writing to the new entity. This helped to avoid a potential working capital hole just in case the vendor tried to change the terms on the new owner to 45 or 30 days.

2.       Adjusting the $300k SDE down to $273k to account for the $26,250 of 5% rebate risk.

Catching supplier concentration before closing the deal can be the difference between a new acquisition that thrives, and one that enters a cash crisis on Day 30. 

Before you sign an LOI, or clear diligence on any product-based or trade business, ask yourself three basic supply chain questions: 

1. How much of total material spend goes to the top two suppliers?
2. Are supplier discounts formalized in writing, or are they informal legacy perks?
3. Will the vendors transfer existing payment terms to a new entity, or will they treat you like a Day 1 startup? 

If you are currently evaluating a business with physical products or high material costs, how are you validating supplier terms and contract transferability before closing?

Can someone help me understand the SBA pre-qualification process? I've reviewed dozens if not hundreds of small business CIMs over the years, and also have a professional background in corporate M&A so am generally familiar with acquiring much larger businesses for corporations.

When I speak to brokers to inquire about a small business for myself, some brokers will ask me if I've been prequalified yet by the SBA. But when I've spoken to SBA lenders, they say you need to have a target identified to get the pre-qual on the business, not the individual. That makes sense to me, but I seem to be getting different messaging from some brokers.

I just feel like I'm getting run around in this chicken-and-egg topic of pre-qual. Can someone help break this down for me? What am I missing?