IOI for manufacturing company

October 05, 2023

by a searcher from Boston University in Boston, MA, USA

I've extended an IOI for a manufacturing company, proposing a purchase price based on a 3 to 3.5x multiple of EBITDA. I kept is very high level. As we delve deeper into the details, are there standards on what should be incorporated in this valuation, such as Accounts Payable (AP), Accounts Receivable (AR), and inventory? Given the significant value of the inventory, any insights from those experienced in navigating these intricacies?

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Reply by a searcher
from Wilfrid Laurier University in Woodbridge, Vaughan, ON, Canada

I agree with the prior comments - it's part of the assets required to generate profitability, and if it weren't included, you would have to put in cash or take on additional debt immediately. Definitely factors into valuation also. For instance, if you're paying 3x EBITDA, and that results in a purchase price that is barely above the working capital level, you'll probably have a tough time reaching a deal. That then gets to the next question: what working capital level to use: could use the latest balance, the latest year-end balance, or an average of multiple years of working capital to set the appropriate target. Or perhaps the target is some amount less than those values, if you think the working capital is elevated or the purchase price need only reflect a certain amount of working capital. Depends on the business, the valuation, and the structure.

Reply by a searcher
from Southwestern University in Houston, TX, USA

A/P + A/R - These are Balance Sheet credits and debits. The overall net positive (hopefully!) asset value on the balance sheet can be taken into account in the final valuation. Generally speaking, our take is that everything on the balance sheet is what went into the profits and is part of the business. So, when we're paying a multiple of profits, we're buying everything.

Inventory just needs to be evaluated properly. Many companies when selling will value inventory at retail, not at wholesale, which is a mistake. Generally speaking, the COGS paid for the inventory should offset against the (wholesale) value of the inventory. The biggest problem with inventory is evaluating how much is actually useful (and turning multiple times a year) and how much is gathering dust (and is essentially valueless for the business).

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