Customer Concentration and the Middle Market Borrower

The customer list runs to a few dozen lines. Most of the bars beside the names are short and roughly even, a spread of regional accounts each buying a little. One bar runs almost to the edge of the page. That single account buys more from the company than the next several combined, and it has done so for years. I look at that page longer than any other in the file, because the long bar is both the reason the loan is on my desk and the reason it could go wrong.

Take a hypothetical contract manufacturer of molded plastic parts. It is well run, profitable and growing. The owner wants to borrow to buy a second production line, because the large customer has asked for more volume and hinted at a new product family. The owner has in mind a loan matched to what the expanded plant would earn. Without the large customer, there is no expansion, no need for the loan, and arguably no business of this size at all. With it, the company has visibility that most midsize manufacturers would envy: a creditworthy buyer, a long relationship, and a pipeline of orders.

That visibility is what makes concentration so tempting to underwrite. A large, steady customer looks like the opposite of risk. The receivables are good. The volumes are predictable. The relationship has survived downturns before. But the same account can end the relationship on notice, move production to a cheaper supplier, bring the work in house, or squeeze price at every renewal, and the smaller company has almost no power to resist any of it.

So I structure the hypothetical loan with both outcomes in view. The amount is sized to cash flow the business could still service if the large account shrank sharply, not to the full expansion case. Receivables from the large customer are advanced against, but the borrowing base caps how much of the total can come from any one name. The lender receives monthly revenue by customer, not just in aggregate. The agreement requires notice if the customer’s contract is terminated, not renewed or materially changed. A cash sweep captures a share of excess cash in the good years. And I ask for a real conversation about the contract itself: its term, its renewal mechanics, who owns the tooling, and what notice period the customer must give before walking away.

The tooling question deserves its own line. In contract manufacturing, the molds that make a customer’s parts are often paid for by the customer and effectively theirs to move. If the customer owns the tooling, the switching cost that seems to protect the relationship is smaller than it looks, because the customer can ship the molds to another plant and resume production within weeks.

Then the file splits.

The first ending: the customer stays and grows

The new line is installed on time. The customer places the larger orders it had hinted at and launches the new product family, which the company is well placed to supply. Revenue rises, the plant runs near capacity, and the cash sweep pays down a meaningful part of the loan within the first couple of years. The monthly reports show the concentration getting worse, not better, because the large customer’s growth outpaces everything else.

In this ending the concentration covenant and the borrowing base cap feel like friction. The owner asks, reasonably, why the lender will not advance more against receivables from such a strong buyer. My reply is that the strength of the buyer was never the question. The question was always the dependence, and a customer growing faster than the rest of the book makes the dependence deeper even as the credit improves.

The right response in this ending is not to loosen everything. It is to use the good years well. The loan balance comes down. The owner, with more cash and a stronger plant, has the means to win a second anchor account, and the lender can encourage it by tying any future increase in the facility to progress in diversifying the book. A good first ending leaves the company with less debt and a customer list whose longest bar is a little less long. That is the best outcome available, and it has to be worked for.

There is also a quieter lesson. The customer’s growth made the company more valuable, and a larger valuation invites a sale or a recapitalization. A lender who has watched the concentration closely is well placed to weigh whether a new buyer is paying for a durable franchise or for one relationship that could leave with the next procurement review.

The second ending: the customer leaves

The line is installed. For a year the orders arrive as expected. Then the large customer runs a sourcing review, qualifies a second supplier in another region with cheaper labor, and moves most of the volume there. It gives the notice the contract requires and not a day more.

This is where the structure earns its cost. Because the customer notice clause was in the agreement, the lender hears about the change at the same time as the owner, not a quarter later when revenue collapses. Because the loan was sized to a case where the account shrank sharply, the company can still service the debt at reduced volume, though with no room to spare. Because the borrowing base capped exposure to one name, the lender’s advance against receivables falls less abruptly than it would have. And because the sweep ran in the good year, the balance is smaller than at close.

The ending is still unpleasant. The new line runs part time. The owner cuts costs, chases smaller accounts and sells surplus equipment. Owner and lender meet more often and talk more frankly. The loan is amended, perhaps with a longer amortization in exchange for more frequent reporting and a firmer path to paying down the balance. But the company survives, and the lender is repaid, because the structure assumed from the start that this ending was possible.

Without those terms, the same ending looks very different. Debt matched to the expansion case, with no notice clause, no concentration cap and no sweep, meets the loss of the anchor account with its full balance outstanding and no warning. The lender finds out from a missed payment, when the options are fewest.

The anchor customer is a source of cash and a single point of failure at once.

The large account justifies the loan in both endings, and the only difference between the manufacturer that pays down its debt while chasing a second anchor and the manufacturer that shrinks into its amended loan with the lender at its side is which way one customer’s sourcing decision fell, which is exactly why the structure has to be written for both before anyone knows.