Latest / The Buyer & Seller Podcast with Fexingo: Business Brokers, Exits, and Private Sales Explained / Why Customer Concentration Killed This Medical Billing Business
Transcript
- Lucas: So last week I was looking at a deal that closed back in March — a medical billing company, 40 employees, clean books, and a niche in anesthesia coding. The owner walked away with about nine million dollars, which sounds great, but here's the thing: he was expecting at least twice that. Luna: Ouch. So what killed the valuation? The business itself looked solid on paper. Lucas: It was solid. That's exactly why the story is such a good warning. The real culprit was customer concentration. Seventy-two percent of the company's revenue came from a single hospital system. And that one number — just that ratio — is what turned a potential bidding war into a one-buyer negotiation. Luna: Seventy-two percent. So every buyer who ran the numbers just walked away? Did some of them still come to the table? Lucas: A few kicked the tires. But what happened is that the hospital system — the dominant client — had a contract that was rebid every eighteen months. So it's 'recurring' revenue in the narrow sense that they kept renewing it, but it's not locked in. Any buyer who looked at that contract knew that a single lost renewal would vaporize 72 percent of the business overnight. That's a risk that no reasonable multiple can compensate for. Luna: Right, so what did the eventual buyer do differently? Why did they take the risk? Lucas: The buyer was a private equity roll-up that already owned three other medical billing firms. They had their own client relationships, and they planned to fold this company's operations into their existing platform. So for them, the concentration wasn't a business-ending threat — it was just a revenue stream they could migrate over time. They had the leverage, and they used it. Luna: So they basically said, 'We're the only ones who can buy this, so we'll pay you 3.2 times EBITDA and you'll like it.' Lucas: Exactly. And the owner had no choice. He'd already told his staff, he'd already hired an advisor, and he'd already mentally checked out. When the other bidders dropped out, the deal momentum was all on the buyer's side. Luna: I have to ask — did the broker try to do anything about the concentration before listing? Like, could they have de-risked it? Lucas: That's the frustrating part. The broker had flagged it early in the process, but the owner didn't want to wait. He wanted to sell in that calendar year, and he didn't want to put effort into courting new clients when he was trying to exit. So they listed as-is. It was a real missed opportunity, because the business was genuinely well run. Profit margins were above 20 percent, the coding team was experienced, and the client retention had been perfect for a decade. But none of that matters if the risk profile screams 'fragile.' Luna: Let's get into what a buyer actually sees when they do a concentration analysis. Because I think a lot of sellers don't realize how systematic this is. Lucas: Most professional buyers will run a simple schedule: they list the top ten clients, the revenue each one generates over the past three years, the contract terms, and the renewal dates. Then they calculate what percentage of revenue is tied to any single client. In this case, the top client was 72 percent. But even the second-largest client was only 6 percent. So there's a massive cliff, not a gradual slope. Luna: And what's the threshold where buyers start getting nervous? Is it like 30 percent, 50 percent? Lucas: There's no hard rule, but in my experience, anything above 25 to 30 percent from one client triggers a deep dive. Above 50 percent, strategic buyers will often just walk away unless they have a very specific reason to stay. In this deal, the buyer's logic was: 'We can keep this hospital system because we have a dedicated client success team and we're already in their EHR ecosystem.' That's a story only a roll-up could tell with a straight face. Luna: So if you're a seller listening to this and you've got one big client, what can you actually do about it? I mean, you can't just magic up new revenue in six months. Lucas: You're right, you can't. But you can do things that make the risk less scary. One is to get that contract converted to a multi-year agreement. If the hospital system had signed a three-year deal with automatic renewal clauses, the buyer's downside would be smaller. Another is to build a documented pipeline of potential clients — even if they're not signed yet, a credible list of conversations with hospitals that are evaluating your services shows that revenue could be replaced. Luna: And I'm guessing the owner didn't have that, either. Lucas: No, he had nothing. No signed contracts beyond eighteen months, no letters of intent, not even a formal business development plan. The buyer's due diligence team literally wrote in their report: 'No evidence of customer diversification strategy.' And that line alone probably cost the seller two turns of EBITDA. Luna: Two turns — so if the multiple went from, say, five to three, that's millions of dollars in the owner's pocket just for having a few conversations. Wild. Lucas: That's the kind of thing that keeps me up at night. Because the fix is not that hard. Even just a letter from the hospital system's CFO saying 'we intend to continue our relationship for the foreseeable future' — that would have moved the needle. But the owner never asked. Luna: I want to get into the actual negotiation dynamic, because I've heard you say before that the leverage in a deal is often determined before you even sit down. How did that play out here? Lucas: When the seller has one viable buyer, the negotiation is not really a negotiation. The buyer made an opening offer at 2.8 times EBITDA, and the owner's advisor countered at 4.5. That just made the buyer more confident — they knew the owner was dreaming. The final price of 3.2 was basically the middle of their own range, and they got it on their terms: 30 percent of the consideration was in an earn-out tied to client retention over two years. Luna: An earn-out tied to the very client that's causing the risk. That's brutal. The seller is now the one carrying the risk they should have been paid to transfer. Lucas: Exactly. And that's the subtle thing about concentration risk — it doesn't just lower the multiple, it shifts the entire deal structure. The buyer gets protection, and the seller ends up betting on the same thing they were trying to sell off. Luna: So what's the takeaway for someone who's thinking about selling in the next couple of years? What should they actually do starting now? Lucas: Start by running your own concentration analysis. Pull your revenue by client for the last three years, calculate the percentages, and be brutally honest about the cliffs. If any client is above 30 percent, start a diversification plan immediately — even if it's just small steps. And look at your contracts from a buyer's perspective: are they cancelable on 60 days' notice, or do they have real term and renewal protections? A buyer is going to read every one of those contracts with a fine-tooth comb. Luna: And what about the owner in this story — did he regret selling? I mean, he got nine million, so it's not exactly a pity party. Lucas: He has mixed feelings. On one hand, he's out of the grind and he's got liquidity. On the other, he told the broker afterward that he wishes he'd spent the two years before the sale building out a sales team instead of assuming the hospital would never leave. That assumption is what cost him the most. Luna: It's a classic story, honestly. And I think it's one that a lot of business owners will recognize. The thing that makes you feel safe — a long-term client — can also be the thing that makes you unsellable. Lucas: Exactly. And it's a matter of degree. A little bit of concentration is normal. Every business has a top client. But when that one client represents more than half your revenue, you're not running a business — you're running a branch office of that client. And buyers know it. Luna: Before we wrap up this deal story, I want to bring up something that's been on my mind — and I think it's relevant to what we talk about every week here. We're able to have these deep, long-form conversations about real deals, real numbers, without any ads, because a small group of listeners chips in a few bucks a month to keep it going. It's the kind of listener-supported model that lets us take the time to dig into a case like this properly. Lucas: Yeah, it's true. We've never run ads, and that's a deliberate choice — it keeps the show independent and lets us talk about things like this without any sponsor pulling strings. If you've gotten value from these conversations, and you've got a couple of bucks to spare, you can find it at buy me a coffee dot com slash fexingo. It literally funds the research and production time that makes episodes like this possible. No pressure, but if it's moved your work forward, it's the most direct way to keep it going. Luna: And we're grateful for every single one of you who already does that. It makes a real difference. Anyway, back to the story — so what did the buyer do with the business after the deal? Has the hospital system actually stayed on? Lucas: From what I've heard, the retention has been fine so far — the earn-out is on track. But the buyer has already started shifting the revenue mix, onboarding two new clients onto the same platform. They're doing exactly what the seller should have done before the sale. Luna: So the buyer is now executing the diversification plan that would have gotten the seller a better price. That's the irony. Lucas: It is. And it's a good lesson for anyone who's thinking about an exit: the time to de-risk is before you put the 'for sale' sign up, not after. Because once the buyers start running the numbers, you're not selling your business — you're selling the story of what that business will look like in five years. And if that story is 'one client decides our fate,' the multiple will reflect it. Luna: Thanks for that. I feel like we could do a whole mini-series on concentration risk, but for now — what's the one number you'd want listeners to remember from this episode? Lucas: The 72 percent. If you've got a client that represents north of 50 percent of your revenue, you've got a concentration problem. And it's not just about the multiple — it's about whether you'll even have a buyer at all. This guy got lucky that a roll-up saw an opportunity. A lot of sellers in his position would have gotten nothing. Luna: And that's the reality we wanted to share. Thanks for listening, and we'll catch you next time with another deal behind the curtain.