Professional Services Due Diligence: How to Measure and Reduce Client Concentration Risk

Understanding Client Concentration Risk in Professional Services M&A

For any professional services firm, landing a large, long-term client feels like a major victory. It provides stability, predictable cash flow, and a strong foundation for growth. But when you prepare for an acquisition or investment, that same anchor client can look like a significant risk to an outsider. The question of how to assess client concentration risk in agency acquisition is one of the most common and critical hurdles founders face during due diligence. Potential buyers are not just acquiring your past performance; they are underwriting your future revenue streams. A high concentration of revenue in one or a few clients introduces uncertainty about the durability of that future.

This process is not about hiding a weakness. It is about understanding how buyers view your business, quantifying the reality of your client base, and building a credible story around your firm’s resilience and growth potential. Successfully navigating this conversation is key to achieving a successful outcome in professional services M&A.

The Buyer's Perspective on Client Risk

Why do acquirers care so much about where your revenue comes from? The answer is simple: they are buying future, predictable earnings. This is the essence of a quality-of-earnings analysis, where an investor scrutinizes the sustainability and accuracy of your reported profits. A concentrated revenue base is a measure of future risk.

High concentration is not inherently a deal-killer, but it always triggers deeper scrutiny. A buyer will see a high concentration figure and immediately ask follow-up questions to understand the context. The reality for most professional services startups is that a large anchor client is often the catalyst for early growth. The distinction that matters is between unmanaged risk and a well-understood, mitigated risk.

A buyer’s concern is less about the number itself and more about what it represents. They need to get comfortable with the stability of that revenue. The difference between a high-risk concentration with a volatile startup on a monthly retainer versus a low-risk concentration with a blue-chip corporate on a multi-year, deeply integrated contract is immense. Your job during due diligence is to provide the context that proves your revenue is durable. This is the core of client risk assessment.

Part 1: How to Measure Client Concentration With a Quantitative Analysis

How do you measure concentration, and what do the numbers really mean? The first step is purely quantitative. Before you can build a narrative, you must know the numbers cold. This calculation can be performed easily using data from your accounting software, whether that’s QuickBooks for US companies or Xero in the UK.

The basic formula for client concentration is: (Annual Revenue from Client / Total Annual Revenue) * 100. This gives you a simple percentage for each client. However, a single snapshot is not enough. To follow due diligence best practices, you need to show the trend. Per common M&A practice, concentration should be calculated for the Trailing Twelve Months (TTM) and for the last two to three fiscal years. This demonstrates the direction of your client base and is a critical part of revenue concentration analysis. For guidance on revenue recognition, refer to standards like IFRS 15.

Two key thresholds will typically trigger an investor’s attention:

• Single Client Concentration: A single client representing more than 15-25% of total revenue is a common threshold that prompts deeper investigation during due diligence.
• Top Client Concentration: The top three to five clients representing more than 50% of total revenue often indicates a broader reliance that needs to be addressed with a clear strategy.

If your numbers exceed these thresholds, it does not mean the deal is off. It simply means the next parts of your analysis—the qualitative deep dive and the strategic narrative—become much more important. A scenario we repeatedly see is a firm's concentration decreasing over the last three years. This trend is a powerful positive signal, even if the current TTM number is still high. This is where the story begins to form.

Part 2: Analyzing Contractual Risk With a Qualitative Deep Dive

My numbers are high. How sticky is that revenue, really? Once the quantitative data is on the table, the qualitative analysis begins. The goal is to prove that the revenue from your key clients is secure, stable, and transferable to a new owner. This involves a thorough contract review process, focusing on specific clauses that impact revenue continuity after an acquisition.

Three clauses are paramount in this review:

1. Termination for Convenience: Does the client have the right to terminate the agreement without cause? If so, what is the required notice period? A 90-day notice period provides a new owner with a reasonable buffer to stabilize the relationship, whereas a 30-day notice period presents a much higher risk.
2. Assignability (Change of Control): Can you legally assign the contract to a new entity upon being acquired? Some agreements require explicit client consent for a change of control. If this clause exists, it represents a significant risk that must be addressed proactively with the client before a deal closes.
3. Exclusivity: Does your contract prevent you from working with other companies in the same industry? This can limit the growth story you present to a buyer, as it effectively caps your total addressable market and hinders customer diversification strategies.

It is important to note that laws governing items like auto-renew contracts and notice periods can vary by jurisdiction. To organize this information effectively, you should create a summary for your top clients that adds crucial context to the raw numbers.

Example Analysis of Key Contracts

Instead of just a table, present the findings as a brief analysis for each key client. This format immediately translates data into insight for a potential buyer.

• Client: Global Tech Inc.
  • Financials: $750,000 in TTM revenue, representing 25% of the total.
  • Contractual Strength: The contract allows for termination for convenience with a 90-day notice period, providing a good runway. The change of control clause permits assignment upon notice, which is favorable. No exclusivity clause is present.
  • Risk Assessment: Despite the 25% concentration, the contractual terms make this revenue appear stable and transferable, significantly lowering the perceived risk.
• Client: Series A Startup
  • Financials: $300,000 in TTM revenue, representing 10% of the total.
  • Contractual Strength: This contract has a 30-day notice period for termination. Critically, the assignability clause requires written consent for a change of control, introducing a major deal risk that must be managed.
  • Risk Assessment: Although a smaller portion of revenue, the weak contractual terms make this client relationship higher risk than Global Tech Inc. Securing consent will be a key action item.
• Client: UK Retail Group
  • Financials: $240,000 in TTM revenue, representing 8% of the total.
  • Contractual Strength: Termination is only permitted for breach of contract, which is very strong. The contract is assignable. However, it contains an exclusivity clause for the UK retail sector.
  • Risk Assessment: The revenue is very secure, but the exclusivity clause may limit future growth in a key market, a point that must be addressed in your strategic growth narrative.

Part 3: Building Your Narrative with Mitigation and Growth Plans

How do you convince an investor that your business is resilient, even with a big client? This is where you shift from presenting data to telling a strategic story. Your objective is to show a buyer that you understand the concentration risk and have a credible, actionable plan to mitigate it. This moves beyond a defensive explanation and into a proactive narrative about diversification and growth. It shifts the conversation from defense to offense.

1. De-risking Key Client Relationships

First, demonstrate that the revenue from your largest clients is not dependent on a single individual, such as the founder. You need to prove the relationship is institutionalized within your firm. Evidence of this includes:

• Multiple Touchpoints: Show an organization chart or relationship map demonstrating that your team is integrated with the client at multiple levels, from executive sponsors to day-to-day project managers.
• Scope Expansion: Provide a history of growing the relationship by solving more problems for the client over time. This proves you are a strategic partner, not just a commodity vendor that can be easily replaced.
• High Switching Costs: Articulate how your firm's processes, institutional knowledge, or proprietary technology are deeply embedded in the client's daily operations, making it difficult, costly, and disruptive for them to switch to a competitor.

2. Crafting a Credible Diversification Plan

This is your forward-looking story, and it must be backed by evidence, not just ambition. A vague promise to "get more clients" is not sufficient. A credible plan is specific, measurable, and already in motion.

Example Diversification Narrative: "While our largest client currently represents 25% of our revenue, our strategic plan for the next 18 months is focused on diversification. Our sales pipeline shows three late-stage deals in the financial services vertical, a new market for us, which collectively represent $400k in potential new annual recurring revenue. Furthermore, we are productizing one of our core service offerings, which we project will attract a higher volume of smaller clients and reduce our top-client concentration to under 15% by the end of next year."

3. Modeling a 'What-If' Scenario

To directly address a buyer's biggest fear, you should proactively model the financial impact of losing your largest client. The goal is to demonstrate resilience. By showing that while the loss would be painful, it would not be catastrophic, you give the buyer confidence in the business's underlying stability.

Here is how to walk a buyer through this scenario:

• Current State: Start with your baseline financials. For example, Annual Revenue of $3,000,000 and EBITDA of $500,000.
• Unmitigated Impact (The Fear): Show the worst-case scenario. If you lose the $750,000 client, revenue drops to $2,250,000. Assuming a 50% gross margin, Cost of Goods Sold falls by $375,000. With operating expenses remaining fixed at $1,000,000, your EBITDA would plummet to just $125,000. This is the scenario the buyer is worried about.
• Mitigated Impact (The Plan): Now, present your contingency plan. The revenue is still lost, but you have a plan to adjust operations. You might reduce specific operating expenses related to that client by $150,000. While some staff might be reallocated, you might plan to retain key team members, adjusting your COGS to $1,200,000. In this planned scenario, your EBITDA stabilizes at $200,000. This shows a buyer that you have a plan, the business remains profitable, and the situation is manageable.

Actionable Next Steps for Founders

Successfully navigating the client concentration issue during an agency acquisition comes down to a three-step process: quantify, analyze, and narrate. First, run the numbers to understand your objective exposure. Second, dive into your contracts to analyze the true stability of that revenue. Finally, build a credible and proactive narrative around risk mitigation and future growth.

Your exit timeline dictates your priorities. If you are planning an exit in the next 6-12 months, your focus should be on analysis and narrative. Document your client relationships, model the what-if scenarios, and prepare your diversification story. You will not have time to fundamentally change the numbers, but you can control the story.

If your timeline is two or more years away, your priority must be execution. Now is the time to implement customer diversification strategies, actively pursue new verticals, and broaden your client base. It is also wise to review foundational elements like your cap table well ahead of a sale. By the time you enter due diligence, the numbers themselves will tell a powerful story of decreasing risk and strategic growth. In any M&A process, context transforms a data point into a narrative, and a strong narrative is what gives buyers the confidence to invest. For more resources, explore the investor due diligence hub.

Frequently Asked Questions

Q: What is a "safe" level of client concentration for a professional services firm?
A: While there is no magic number, most investors feel comfortable when a single client represents less than 15% of total revenue. However, the trend is more important than the absolute number. Demonstrating a consistent decrease in concentration over several years is a very powerful and positive signal.

Q: Can I still get a good valuation with high client concentration?
A: Yes, it is possible. A high valuation can be achieved if the concentrated revenue is of extremely high quality. This means long-term, deeply embedded contracts with blue-chip clients, high switching costs, and a strong, evidence-backed diversification plan. The buyer may, however, adjust the valuation multiple to account for the perceived risk.

Q: How should I talk about client concentration with a potential buyer?
A: You should address it proactively and transparently. Present your quantitative data, qualitative contract analysis, and mitigation plan before the buyer has to ask for it. Framing the issue as a well-managed and understood risk, rather than a hidden weakness, builds trust and demonstrates strategic foresight.

Q: Does the client's industry affect how concentration risk is perceived?
A: Absolutely. Concentration with a stable, well-funded corporate client in a non-cyclical industry is viewed as far less risky than having the same level of concentration with an early-stage startup in a volatile sector. The context of your client's business is a critical component of your risk narrative.