How does inventory and backlog factor into valuation?

February 09, 2024

by a searcher from Southwest Texas State University in Dallas, TX, USA

I’m looking at a deal where the rough EBITDA is <$1M
In an industry with 2-4x mulitiples. Seller is suggesting a valuation in the range of $10m due to having $9M in backlog and $6M in inventory.

How does BL and inventory factor into valuation calculation relative to SDE and/or EBITDA multiples?

Thanks!

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Reply by an intermediary
from Clemson University in Raleigh, NC, USA

I'd like to add the backlog has value, but this seller is overweight on how much. I've never seen a business in the lower middle market worth 10x aside from one transaction I completed with a public company at ~29x (another story for another time). The fact is buyers EXPECT there to be backlog. If there was nothing in the pipeline the business would be worth less. Sellers who think a backlog is special are mistaken - it's expected. Now again we have an issue of 'excess backlog'. In this situation there is risk of cancelled orders. I have a commercial cabinet company with a $10,000,000 backlog with $9,000,000 in gross revenue. It's not at risk a year+ out because the clients won't be ready for them before then as they are at various stages of construction themselves. Is that a positive? Yes, but not to the tune of 10x adjusted EBITDA. The seller will receive a slight premium to cover the sales and engineering expense, but nothing close to even one turn of EBITDA.

Reply by a professional
from The College of New Jersey in La Verne, CA 91750, USA

Late to the party here, but is this true backlog (work that has yet to be completed and revenue/expenses yet to be collected/incurred)? Or is it a service obligation where revenues have already been collected (i.e., deferred revenue in the accounting world)? Backlog has value if there's a benefit to be had from it. It reduces the risk associated with future revenue because it is already secured. However, poorly priced contracts can result in projects that are not profitable, which then begs the question of whether you really want to buy it.

Backlog doesn't always have value and oftentimes terminology gets mixed up. Aside from the above, backlog is finite and may not necessarily recur in the futureso paying a multiple on backlog would not make sense.

I agree with what has already been stated regarding inventory. We see lots of deals these days with big working capital adjustments because sellers held inventory on the books that wasn't going to turn.

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