Asset purchase and how to treat inventory

professional profile

November 29, 2023

by a professional from New York University - Leonard N. Stern School of Business in New York, NY, USA

Looking at a business that has inventory which could be easily liquidated (e.g., lumber, plywood, etc.). Current owners have no revolvers or LOCs to fund inventory; they use the cash from the business. There is no other debt either. Structuring as an asset sale to do my best to separate from any historical exposures I know exist based on initial discussions with the seller. I'm valuing the business based on EBITDA and giving an extremely fair multiple; maybe even a bit on the high side. However, sellers think inventory should be added to Purchase Price. Curious to hear thoughts. Appreciate your perspectives.

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Reply by an investor
from United States Naval Academy in Colleyville, TX 76034, USA
I've given this advice before, it's analytically challenging but gets to a "fair" outcome (fair ultimately being what you can negotiate). Some industries have standard deal terms (example "3x + inventory) but if they don't...

1. Determine the enterprise value as a going concern based on cash flow (sounds like you've already done this).
2. Determine what the normal working capital on the balance sheet should be in a going concern (the hard part). This should be part of the EV.
3. Adjust the price based on the level of working capital that is being transferred. If they have excess inventory, up the price to buy it. If it's below nominal, have them leave cash or discount the price to account for that.
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Reply by an intermediary
from The University of Chicago in Chicago, IL, USA
Run a financial model that gives you ROI you are ok with and it services debt. Use price (P) in your model that includes everything to generate the EBITDA. After that, you can offer the seller the price P (which includes everything) or a lower price (p) which will exclude certain assets/liabilities (like inventory).
A buyer should not be buying a business based solely, or primarily, on multiples; either you will overpay or loose a good opportunity.
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