Why Client Concentration is a Major Risk Factor in CPA Firm Sales

When you’re running a CPA firm, it’s easy to focus on the day-to-day operations—making sure your clients are happy, keeping up with tax laws, and growing your business.

But what happens when you decide it’s time to sell? There’s one critical factor that could derail your plans, and it’s something many CPA firm owners overlook: client concentration.

In this article, we’ll break down why client concentration is a significant risk factor in CPA firm sales, how it can slash your firm’s value, and what you can do to mitigate this risk well before you’re ready to sell.

Whether you’re thinking of selling now or in the future, this is crucial information you can’t afford to ignore.

What Is Client Concentration and Why Should You Care?

Understanding Client Concentration

Client concentration refers to a scenario where a large portion of your firm’s revenue comes from a small number of clients.

For example, if just two or three clients make up 40% or more of your firm’s total revenue, you have a client concentration issue. While this might not seem like a big deal when business is good, it can become a major problem when it comes time to sell.

Why It Matters in CPA Firm Sales

Potential buyers see client concentration as a huge red flag. Here’s why:

• Revenue Stability: If a large chunk of your revenue comes from just a few clients, the loss of one or more of these clients post-sale could lead to a significant drop in income.

• Perceived Risk: Buyers are looking for stability and predictability. A firm heavily reliant on a few clients is viewed as risky because those clients might not stick around after the ownership change.

• Impact on Valuation: High client concentration typically leads to lower offers. Buyers may request more stringent terms, such as earn-outs, to mitigate the perceived risk.

As one CPA M&A advisor noted,

“Client concentration is a red flag for buyers. It indicates that the firm’s revenue is heavily reliant on a few relationships, which could easily vanish post-sale.”

The Risks of High Client Concentration in CPA Firm Sales

1. Revenue Volatility

Imagine selling your firm only to see the buyer lose a major client within the first year. That’s revenue they counted on that’s now gone, and it could lead to a failed deal or legal disputes. This volatility makes high client concentration a risky gamble for any buyer.

2. Reduced Buyer Interest

When you’re ready to sell, you want as many interested buyers as possible to drive up the price. High client concentration can drastically reduce the pool of potential buyers. Firms with diversified client bases are far more attractive because they’re perceived as more stable.

A CPA M&A expert explains,

“Most buyers are looking for stability. A firm with high client concentration is perceived as risky and unpredictable.”

3. Price Reduction & Deal Structuring

Even if you find a buyer, high client concentration can lead to a lower sale price or unfavorable deal terms. Buyers may insist on an earn-out, where part of the sale price is contingent on the firm retaining its key clients over time. This means you won’t see all your money upfront and could lose out if those clients leave.

Hypothetical Scenario: A CPA firm with 50% of its revenue tied to one client had to accept an earn-out deal. The seller received only 60% of the sale price upfront, with the remaining 40% dependent on the firm’s performance over the next two years.

How to Identify if Your CPA Firm Has a Client Concentration Problem

Analyzing Your Revenue Streams

The first step in addressing client concentration is understanding your firm’s current situation. Here’s a simple way to assess it:

1. List Your Clients: Write down your top 10 clients by revenue.

2. Calculate Revenue Percentage: Determine what percentage of your total revenue each client contributes.

3. Identify Red Flags: If any single client contributes more than 10-15% of your total revenue, it’s time to take action.

Benchmarking Against Industry Standards

It’s essential to know where your firm stands compared to others in the industry. Generally, a healthy CPA firm should aim for no single client contributing more than 10-15% of its total revenue.

One industry expert advises,

“A healthy CPA firm should aim for no single client contributing more than 10-15% of its total revenue.”

Red Flags to Watch For

Be on the lookout for these warning signs that indicate your client concentration might be too high:

• Overreliance on One Industry: If most of your clients come from a single industry, a downturn in that sector could hit you hard.

• Revenue Dependence on a Few Clients: Even if you have many clients, if a few of them contribute a disproportionate amount of revenue, you’re at risk.

• Limited Client Acquisition: If you’re not actively bringing in new clients, your concentration risk could worsen over time.

Strategies to Mitigate Client Concentration Risk Before Selling

1. Diversification of Client Base

The most effective way to reduce client concentration risk is by diversifying your client base. Here’s how:

• Target New Industries: Consider expanding into different industries where you currently have little to no presence.

• Geographical Expansion: Look for clients in different regions to spread out your revenue sources.

• Upsell to Smaller Clients: Deepen relationships with smaller clients by offering additional services, increasing their revenue contribution to your firm.

2. Long-Term Planning

If you plan to sell your firm in the next 3-5 years, now is the time to start reducing client concentration. Here’s why:

• Gradual Change: Diversifying your client base takes time. The sooner you start, the more stable your revenue will be when you’re ready to sell.

• Enhanced Firm Value: A diversified client base not only reduces risk but also makes your firm more attractive to buyers, potentially increasing its value.

An industry expert advises,

“The best time to start reducing client concentration is now. Waiting until you’re ready to sell can significantly reduce your options.”

3. Strengthening Client Relationships

While you’re working on diversification, it’s also important to strengthen relationships with your existing smaller clients. This can help increase their revenue contribution and reduce your reliance on the bigger ones.

• Personalized Service: Offer tailored services that meet the specific needs of your smaller clients.

• Regular Check-ins: Maintain regular communication to stay top-of-mind and identify new opportunities to add value.

Conclusion: Take Control of Your Firm’s Future

Client concentration is a serious risk factor that can drastically reduce the value of your CPA firm and make it harder to sell. By understanding this risk and taking proactive steps to diversify your client base, you can protect your firm’s value and ensure a smoother, more profitable sale when the time comes.

Call to Action: Don’t wait until it’s too late. Take a close look at your firm’s client concentration today and start implementing strategies to reduce your reliance on a few key clients.

Want to know how to turn a high client concentration to your advantage? Take a look at this article.

Taking control of your firm’s future starts now. Start diversifying today to secure a better deal tomorrow.