Customer Concentration, and the Seller Note That De-Risks It

There's one page in your target's data room that a credit officer will find in about ninety seconds, and it can decide your deal before anyone reads your model.

It isn't the P&L. It isn't the tax returns.

It's the accounts receivable aging, because that's where your biggest customer is hiding in plain sight. It answers the question lenders really want to know: if this one relationship ends, does the loan still get paid?

I've watched deals with beautiful EBITDA die on that page, and I've watched deals with a 40% customer sail through committee because the buyer structured for it before the bank ever asked.

The difference between those two outcomes is this week's issue.

But first, come have a drink with me next month.

Upcoming Event

Madison ETA Happy Hour

Thursday, August 20, 4:00 to 7:00 PM Central at Wisconsin Brewing Company, 1079 American Way, Verona, WI, just outside Madison. I'm co-hosting with my friend Chris Barrett, Founder and Owner of Midwest CPA.

If you're a current or prospective business buyer, your first three drinks are on Pioneer Capital Advisory and Midwest CPA. It's a casual evening for searchers, operators, investors, and anyone ETA-curious in the Madison area. Grab a drink, make some connections, and talk deals (customer concentration horror stories welcome). The event is free. Just reserve your spot so we know you're coming.

​RSVP here​

A Story From This Week: The ABL Idea That Sounded Clever

I had a call the other week with a searcher looking at an industrial products distributor in the Midwest.

Solid business on paper: mid eight figures of revenue, just under $1M in EBITDA, priced in the low $5M range, with a couple million dollars of accounts receivable and a healthy pile of inventory sitting on the balance sheet.

His idea was one I hear a few times a year, and it always sounds smart the first time you say it out loud. Rather than maxing out the SBA 7(a) loan, he wanted to pair a smaller SBA loan with an asset-based lending (ABL) facility against the AR and inventory. Free collateral, less SBA debt, more conservative.

What's not to like?

Here's the problem, and it's an SOP problem, not a bank preference problem. If the AR and inventory are included in the purchase and 7(a) proceeds are funding that purchase, the SBA lender has to take a first lien position on those assets.

There's no negotiating your way around it by pointing at the DSCR. The only way to bring a true ABL lender in at closing is to carve the AR and inventory out of the purchase agreement entirely and buy them in a separate transaction. I've worked on hundreds of these over 11 years, and I have never once seen that structure get across the line on an acquisition.

You'd need two purchase agreements, an intercreditor agreement, and two lenders each underwriting the other's debt service, and the ABL money costs more than the senior money anyway, because the ABL lender is less collateralized.

The in-program answer is an SBA CAPLine: a revolving line with a borrowing base against current AR and inventory. The catch is that the 7(a) loan and the CAPLine share the same $5M cap, so a $4.5M acquisition loan leaves you $500K of revolver, not $2M.

But here's the part of the call that actually mattered, and it had nothing to do with the ABL.

When we got to his personal balance sheet, he was a classic self-funded searcher profile:

Essentially all of the equity coming from an investor, and personal liquidity that was very thin. On deals around the $5M mark right now, banks are drilling down hard on post-close liquidity.

Many want to see something like $100K liquid after the injection, in the buyer's own name, cash or marketable securities. Investor capital in the deal does not solve it. A clever second facility does not solve it.

So I told him the honest thing: I didn't think I could place the deal as structured, and I didn't want to burn his time pretending otherwise.

But I also gave him the path I'd take in his shoes: figure out the cash the seller truly needs at closing, raise that piece from investors, buy the business with the majority of the price on a seller note, make two years of current payments, and then refinance the seller note with an SBA loan once the business's cash flow has fattened up his personal balance sheet. It's slower. It also actually works.

The broader lesson from that call runs through everything we do: the winning move is almost never engineering around the lender's rules. It's designing your structure to work with them. And there's no place where that principle earns its keep faster than this week's topic.

Because when a business has a couple million dollars of AR on the books, remember the page from our cold open. The credit officer is going to read that aging, and the question isn't whether the receivables are collectible.

The question is who owes them. If the answer is "mostly one customer," keep reading.

Customer Concentration: How Lenders Actually Think About It

Customer concentration is one of the most common reasons a genuinely good business gets a hard look — or a decline — in SBA underwriting. And like most credit topics, the way buyers think about it and the way lenders think about it are not the same.

Buyers tend to frame concentration as a business risk: "What happens to revenue if we lose them?" Lenders frame it as a debt service risk: "What happens to the loan payment if they lose them?"

Same customer, very different math, because a lender doesn't participate in your upside. Their best case is that you make every payment. Concentration threatens the only outcome they care about, which is why it gets weighted so heavily relative to how it feels on the buy side.

Where it surfaces in diligence

You don't get to decide when the concentration conversation happens. It happens when the lender receives:

• The customer-level revenue schedule. Most lenders (and every quality-of-earnings provider) will ask for revenue by customer for the trailing two to three years. If the seller "doesn't track that," that answer is itself a diligence finding.
• The AR aging. Even without a customer schedule, a concentrated book announces itself here.
• The contracts folder. Or the absence of one.

Which means the worst possible plan is hoping the topic doesn't come up. It will come up, it will come up early, and the buyer who raises it first — with a mitigation structure already attached — controls the narrative. The buyer who lets the lender discover it is playing defense for the rest of underwriting.

Measure it in gross profit, not just revenue

One refinement that separates sophisticated files from average ones: concentration should be measured in gross profit contribution, not just revenue. A customer that's 30% of revenue at half the blended margin is a much smaller credit problem than the headline suggests. A customer that's 20% of revenue at double the blended margin is a much bigger one. When we package a concentrated deal for lenders, we present both cuts, because if we don't, the underwriter will assume the worse version.

The thresholds (such as they are)

The SOP doesn't say "decline any deal where a customer exceeds X%." Concentration lives in each bank's credit policy, and appetite varies widely. As a rough map of the market: most lenders start asking questions when a single customer crosses 20% of revenue, get genuinely cautious somewhere in the 30s, and many have a hard stop when one relationship approaches or exceeds half the business.

Some banks also look at top-five concentration - a business where five customers make up 80% of revenue has a concentration problem even if no single name crosses 20%.

This is exactly the kind of bank-by-bank variance we screen for when we take a deal to market. The same file that dies at one bank gets a term sheet at another, not because anyone is being irrational, but because their credit boxes are genuinely different. On a concentrated deal, lender selection isn't half the battle. It might be most of it.

The stress test

The core exercise a credit officer runs is simple: remove the concentrated customer's contribution from the cash flow and re-run the DSCR.

Walk through the math with me, because you should be running this on your own deal before any lender does.

Say you're buying a business with $1M of EBITDA, and the proposed structure carries $560K of annual debt service, a comfortable 1.79x base-case DSCR that any lender would happily underwrite.

Scenario A: the top customer is 30% of revenue at margins similar to the rest of the book. Strip them out and EBITDA falls to roughly $700K. Stressed DSCR: 1.25x. The deal still covers — thinly, but it covers. This is a discussion: the lender will want to understand the relationship, see the mitigation plan, maybe trim leverage modestly. But there's a path.

Scenario B: the top customer is 50% of revenue. Strip them out and EBITDA falls to roughly $500K. Stressed DSCR: 0.89x. The loan does not service in the downside scenario, which means the lender isn't underwriting a business anymore - they're underwriting one commercial relationship with a personal guarantee attached.

The only ways to fix that: less senior debt, more seller paper, more equity, or a smaller price.

Two things to internalize from that math.

First, the difference between "workable" and "unfinanceable" concentration is often not the percentage itself, it's whether the stressed case clears 1.0x, which is a function of leverage as much as concentration. Second, if you know your deal produces the Scenario B math, you know your capital structure before the negotiation starts. That's not bad news. That's your LOI strategy handed to you in advance.

Not all concentration is created equal

Once the percentage clears the stress test, underwriting shifts from how much to what kind. This is where deals get won, because the quality of the relationship is something you can actually diligence and document.

The paper. A multi-year written MSA or supply agreement is a different animal than a long relationship transacted PO by PO. Read the actual terms, not just the existence of a contract: termination-for-convenience clauses, notice periods, exclusivity, pricing reset mechanics. A "three-year contract" the customer can exit on 30 days' notice is 30 days of security wearing a three-year costume.

Change of control. This is the clause buyers skip and lawyers don't. Does the contract survive the sale? Does it require the customer's consent to assign? In a stock sale it may ride along; in the asset sale structure most SBA deals use, assignment provisions get triggered. A contract that terminates or re-opens on change of ownership is, for underwriting purposes, barely a contract, and discovering that in week six of exclusivity is a bad day.

Who owns the relationship. If the seller personally is the reason the customer stays: the cell phone they call, the handshake they trust. Then the concentration risk and the key-person risk are the same risk wearing two hats. Ask bluntly in diligence: who at the customer does the seller talk to, how often, and who else at the target has a relationship there? If the honest answer is "just the owner, just the one purchasing manager," you've found the single thread the whole deal hangs by.

The tenure. Fifteen years of steady, boring orders reads very differently than a two-year-old relationship that recently spiked, especially if the spike is what produced the EBITDA you're paying a multiple on. Pull the customer's revenue by year and look at the shape, not just the total.

The economics. Outsized margins on the concentrated account are a red flag dressed as good news: they're exactly what a new procurement manager rebids. Market-rate pricing with genuine mutual switching costs — tooling, certifications, integration, geography, is the durable version.

Here's the punchline of this section, and it's one lenders will agree with: a 35% customer with a surviving contract, institutional depth, and long tenure can underwrite better than a 25% customer held together by the seller's golf schedule. Percentage gets the conversation started. Quality decides how it ends.

The De-Risking Toolkit

When we structure a deal with meaningful concentration, we're generally pulling on several of these levers at once. And the sequencing matters, because each one makes the next easier to negotiate.

Layer 1: Price the risk. The bluntest tool. A business with a 40% customer should not trade at the same multiple as the identical business with a diversified book, and the customer-level revenue schedule is your negotiating exhibit. If the seller wants a clean-book multiple, the seller can help carry clean-book risk — which is a natural segue to every other layer.

Layer 2: Shift more of the price into a seller note. A larger seller note reduces senior leverage, which directly improves the stressed DSCR. Remember, the stress case is a leverage problem as much as a concentration problem. It also keeps the seller economically invested in a smooth handoff for years, not weeks. Useful on its own; far more powerful when part of it becomes contingent (Layer 5).

Layer 3: Lock in the transition. A real transition period (and know the program's boundary here before you promise the seller anything). On a complete change of ownership, the SOP generally does not allow the seller to remain as an officer, director, stockholder, or employee; where a transition is needed, the business may contract with the seller as a consultant for a period not to exceed 12 months, including any extensions (SOP 50 10 8, Section A, Ch. 4).

That means the customer handoff cannot be a someday project; it has to be front-loaded into the window the program actually allows, ideally with the warm introductions happening in the first 90 days. Joint customer meetings, with the seller making a warm, planned introduction (handled carefully and with the seller's cooperation on timing and confidentiality, a clumsy early approach can spook the exact customer you're trying to keep). Where a contract exists, written assignment or consent obtained as a closing condition. Lenders notice when the customer has met the buyer and the relationship has a documented handoff plan; it converts a story into evidence.

Layer 4: Oversize the cash cushion. Concentrated deals should close with a bigger working capital bucket and stronger post-close liquidity than their diversified cousins — for exactly the reasons we covered in the working capital issue. If the downside case arrives, cash is what buys you the quarters you need to replace the revenue. A concentrated deal that closes with a thin cushion has stacked its two most dangerous risks on top of each other.

Layer 5: the sharpest tool in the drawer, and the one I promised in the subject line.

The Contingent Seller Note

Here's the concept in one sentence: a portion of the seller note is forgiven if the concentrated customer leaves.

Think about what that does to the negotiation. The seller has spent the whole process telling you the customer relationship is rock solid — fifteen years, practically family, nothing to worry about. The contingent note is how you say: great, then this provision will never cost you a dollar. The seller keeps skin in the game on the one risk they are uniquely positioned to vouch for, and your downside in the bad scenario shrinks by exactly the amount of debt that disappears. It converts the seller's confidence from a talking point into a term.

The SBA context you need first

One important piece of program mechanics before the examples. The SOP does not allow earnouts — on a change of ownership, the purchase price cannot ratchet up based on future performance. Straight from the source:

But a seller note with forgiveness provisions works, because the adjustment only runs down. The price is fixed at closing; the note simply gets smaller if a defined bad event occurs. That one-directional structure is what keeps it inside the program. There is one hard limitation on where that forgivable paper can sit in your capital stack, though. It's in the drafting mechanics below.

As always: your attorney drafts it, your lender blesses it, and both see it early, not at the closing table.

Three anonymized structures from the field

Details changed on all of these.

Structure 1: The pro-rata step-down. A commercial services acquisition — call it $4.2M — where the top customer, a facilities management firm, drove about 34% of revenue. The structure carried an $840K seller note with a contingency measured over the first 24 months:

• Baseline written into the note: $1.9M of trailing-twelve-month revenue from the named customer, per the financial statements.
• Trigger: if measured revenue from that customer fell below 75% of baseline during the window, forgiveness kicked in.
• Formula: principal reduced in proportion to the shortfall against baseline, capped at 50% of the note ($420K).

To make it concrete: suppose the customer cut its spend to $1.1M, a roughly $800K shortfall, or about 42% below baseline.

The note would shed approximately $354K of principal (42% of $840K), and the buyer would be servicing a materially smaller debt stack in exactly the scenario where cash flow got hurt.

Customer stays at or near baseline: seller collects every dollar, and the provision cost them nothing.

Structure 2: The cliff with a burn-off. A light manufacturer with roughly 40% of revenue tied to a single OEM under a contract coming up for renewal after close. The note carried a cliff: if the OEM terminated or declined to renew within the first 18 months, a defined percentage of the note was forgiven outright — with the protection stepping down on a schedule after that (full protection in the renewal window, half in the following period, gone thereafter).

The logic of the burn-off matters. The transition window is when concentration risk is really the seller's risk: was the relationship as sturdy as represented, or was it held together by a personal bond that doesn't transfer? Once the buyer has owned the relationship through a full renewal cycle, losing the customer becomes ordinary business risk, and ordinary business risk belongs to the buyer. Sellers accept burn-offs far more readily than open-ended contingencies, because there's a date on the calendar when the sword gets put away.

Structure 3: The offset for replacement revenue. A B2B services deal where two related customers made up about half the book. Quarterly measurement against a baseline, with pro-rata forgiveness — but with a twist that got the seller to yes: new revenue the buyer landed in the same service line offset the shortfall before any forgiveness triggered.

That offset kept the provision honest in both directions. It protected the buyer against losing the business the concentration represented — not against ordinary churn he could replace through his own selling effort — and it eliminated the seller's real fear, which is that the buyer coasts, loses the account through neglect, and collects a discount for it. When a seller resists a contingency, the replacement-revenue offset is very often the concession that closes the gap.

Drafting mechanics that make or break it

• Objective triggers only. Named customer (including affiliates and successor entities — procurement departments reorganize), a defined dollar baseline, a defined measurement window and cadence, and a forgiveness formula a spreadsheet can compute. The moment the trigger requires judgment — "material deterioration of the relationship" — you've drafted a lawsuit, not a protection.
• Decide what counts as "the customer leaving." Full termination is easy. Partial reduction is where the drafting earns its fee: that's why Structure 1 uses a percentage floor rather than a binary trigger.
• It's a downside tool, not a coverage tool. A contingent note does not improve your day-one DSCR, and lenders will still run the stress case without the customer. What it changes is what the downside costs you — smaller debt stack, seller sharing the pain, a recoverable situation instead of a fatal one. On the margin, that's often the difference between a credit committee getting comfortable and passing. Frame it to the lender that way.
• A forgivable note cannot do down-payment duty. This is the hard structural rule, so let's anchor it in the SOP. Seller debt can only count toward your 10% equity injection under narrow conditions:

The standby debt the SOP is describing — no payments of principal or interest for the term of the 7(a) loan, documented on SBA Form 155 or the lender's equivalent standby agreement — is a fixed, unconditional obligation that simply waits its turn behind the SBA loan. A note with forgiveness provisions is neither fixed nor unconditional. So here is the rule to write down: if a seller note carries forgivability, it cannot be used toward the down payment. The equity injection is supposed to represent real, committed capital standing behind the deal, and your lender must verify every dollar of it before disbursing. Paper that can shrink or vanish based on future events doesn't qualify — and a lender who catches the conflict in underwriting will make you restructure at the worst possible moment, with your exclusivity clock running.

• The clean solution: two tranches, two jobs. Split the seller paper. Tranche A is a plain full-standby seller note — no contingencies, no forgiveness provisions, Form 155 — doing injection duty, up to half of the required injection. Tranche B is a separate seller note carrying the customer contingency, sitting entirely outside the injection math, on whatever payment terms the deal supports. Same seller, same closing table, two documents, zero ambiguity about which dollars are doing which job. Every contingent-note structure described in this issue was built with the contingency housed outside the injection.
• Your lender will read every word, so write it for them too. The SOP requires the lender's credit memorandum to address "the terms of any seller financing and standby agreements" (SOP 50 10 8, Section A, Ch. 7). Your contingency is not a side letter the bank skims — it's a document the credit team must analyze, describe, and keep in the file. A clean, objective, downward-only provision reads as thoughtful structuring. A convoluted one reads as a dispute waiting to happen, and credit committees decline disputes-in-waiting.
• Ask your CPA about the tax side before you sign. Forgiveness of debt can have tax consequences for one or both parties depending on how the adjustment is characterized — purchase price adjustment versus cancellation of debt is a real distinction with real dollars attached. This is a conversation for your CPA and the seller's CPA at drafting time, not at forgiveness time. (Chris and I will happily take this question at the happy hour, though he may require you to use one of your three free drinks on him first.)
• Sellers say yes more often than buyers expect. A confident seller hears "this costs you nothing if what you've told me is true." And a seller who fights hard against a reasonably-sized contingency on the exact relationship they've spent months praising is telling you something worth knowing before you wire the money. Sometimes the negotiation is the diligence.

When to Walk

A candid coda, because structure can't fix everything. If the stressed case fails badly and the contract doesn't survive close and the relationship lives entirely in the seller's cell phone and the seller won't carry meaningful contingent paper — you don't have a financing problem. You have a business you shouldn't buy at this price, and every one of those signals arrived before you spent real money. The toolkit above exists to de-risk good businesses with lumpy books. It is not an alchemy kit for turning one customer with an invoice history into a company.

The 60-Second Version

• Lenders underwrite concentration as a debt service question: strip the customer, re-run the DSCR. Above 1.0x stressed is a discussion; below it, the structure has to respond. Run this math before going under LOI.
• Measure concentration in gross profit, not just revenue — and present both cuts to your lender before they assume the worse one.
• There's no universal threshold. It's bank-by-bank credit policy, which makes lender selection most of the battle on a concentrated deal.
• Quality beats percentage: surviving contracts, institutional relationships, long tenure, and market pricing can make a 35% customer underwrite better than a fragile 25% one.
• The toolkit stacks: price the risk, enlarge the seller note, lock in the transition, oversize the cushion, then add the contingency.
• The contingent seller note is the sharpest tool: forgiveness if the named customer leaves, objective triggers, downward-only (the SOP prohibits earnouts; forgiveness runs the allowed direction), tax treatment sorted with your CPA, drafted by counsel and blessed by your lender early.
• And the tranche rule, verbatim into your deal notes: a seller note with forgivability cannot count toward your equity injection. Injection-duty paper lives in its own clean, unconditional full-standby tranche on Form 155 (up to half the injection, per the SOP); the contingency lives in a separate note outside the injection math.
• And sometimes the seller's reaction to the contingency is the most valuable diligence you'll run.

Thanks for reading!

If you're working on an acquisition, or are in the pre-LOI phases, you can book a short, informal call here to meet our team and learn how we can help you.

For pre-LOI buyers ready to explore opportunities: Schedule a meet & greet call​

Already have a deal under LOI and need financing help: Schedule an LOI consultation​

Until next time,

Matthias Smith

President, Pioneer Capital Advisory

​www.pioneercapitaladvisory.com​
​

Disclaimer: The information in this newsletter is for informational purposes only and should not be considered legal or financial advice. Business buyers are encouraged to consult with their legal counsel and accountant to ensure the proper structuring of their transactions and to fully understand the tax implications of seller financing.

Thanks for reading. Feel free to reply directly to this email with any questions or thoughts.