Dealing with Inventory in an LOI

December 14, 2023

by a searcher from Yale University - School of Management in Juno Beach, FL 33408, USA

How do you deal with inventory in an LOI? The seller claims it is A LOT of inventory, and I can't inspect it and get a value on it before signing the LOI and doing DD.

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Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I think what you need to first do is try to back into what a normalized level of inventory is for the company and what is required to operate the company. In theory if you are buying the company for full price, that company should come with sufficient working capital and inventory for you to be able to step in and run it from day 1. If you are buying the company for a lower value than market, then it might be reasonable for you to pay the seller for the inventory as well. If there is excess inventory that might not be needed then you have two options. The first option would be to purchase the excess inventory at time of closing. The second would be to take a consignment of the excess inventory at closing and pay the seller on that portion of the inventory over time.

The one thing you want to be sure you do is allow for a proper assessment of the inventory during due diligence and the ability to discount down the inventory for any stale or un-useable inventory. You do not want to end up having to pay for inventory that at the end of the day does not have any value. It is not uncommon for small business owners not to have an accurate inventory count. This can work against you, but in some cases it might also work in your favor. I have had some clients end up with substantially more value in inventory post close then they thought they had at the LOI stage, and they never paid for it because the seller's accounting of inventory was bad.

I hope this information is helpful. If you would like to discuss further you can reach me here or directly at redacted Good luck.

Reply by a searcher
from Massachusetts Institute of Technology in Boston, MA, USA

We have come at it from many different ways - it becomes situation, business and somewhat industry dependent very quickly. We had one LOI submitted where the balance sheet showed close to $4MM of inventory and we based the purchase price as a multiple of EBIDTA (with almost no dependence of price on inventory value.) This was a legacy wholesale business which had carried a lot of inventory over the years. We had no way to know if the claimed $4MM value was right or not etc. but we moved the ball forward in the LOI as I have described above. In this scenario, we actually particularly did not care about the inventory value if it was too far off from the balance sheet value given that the business was performing optimally with the inventory set it had.. In another business, with a level of inventory at $3MM, while we still based the LOI price and structure on multiple of EBIDTA, we called out that we would make a full adjustment in working capital amount based on a TTM calculation. after having the inventory properly valued during the due diligence process (and naturally also taking into account the A/R and A/P). And, in another LOI, we structured it so that price of business and inventory was added separately (specifically because the seller insisted), essentially paying a dollar for dollar cost price of inventory. So, essentially, my take is, that one has to look at the business fundamentals and then link the operational reality to the numbers to make a good judgment on what makes best sense in a situation. Hope this is helpful in some way!

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