Rule of thumb, SDE multiple and inventory?

November 14, 2023

by a searcher from California Polytechnic State University - San Luis Obispo in Oakland, CA, USA

Hey all,

When talking about price/SDE multiple being in the 2-4x range being ideal, do you include the cost of inventory in that price numerator?

I've seen conflicting opinions on this so I wanted to gauge how everyone's been thinking about it.

So far, I've been thinking of it as INCLUSIVE in the price so it pushes the multiple up to be what I consider normal.

The reason why I ask is because I see a lot of listings that have a seemingly great multiple and then when you get more info it mentions that inventory was NOT part of the advertised price so it goes from being a 2x multiple to a 2.5 or 3x.

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

Typical mainstreet multiples are 2x-3x seller discretionary cash flow and lower middle market multiples 4x-6x adjusted EBITDA. It's obviously critical that the adjustments be defensible. Industry-wide the accepted standard is that all of the assets required to generate the net profit (either SDCF or EBITDA) are included in the price. That explicitly includes normalized inventory as of the date of closing. Excess inventory can be added or consigned. In lower middle market transactions seller is expected to provide buyer with adequate working capital as well. Working capital calculations need to be realistic. Many inexperienced buyers think the WC is a cash grab opportunity - it's not. It will kill your deal. Be realistic. I completely disagree that inventory is added to SDE multiples. It's not. Only excess inventory.

Reply by a searcher
from Millersville University of Pennsylvania in Mantua Township, NJ, USA

Some good answers already hear. One of the other keys I think you need to consider is the sophistication of the seller and their broker. While it may be most advantageous to include inventory in the multiple this makes it more complicated to support your offer to a less sophisticated buyer. There's probably not a "right" answer, more or less about how you can get creative with the deal terms to have it make sense for you and for the seller. At the end of the day you're going to have a total debt payment that you need to pay out of the cash being generated by the business, and you'll need working capital both inventory and other physical assets and cash to operate the business. So whatever you think you need for cash aspect of working capital plan for more than that because you wont be as dialed in as the seller was.

Anyway...not sure if this answer actually helped, but just another piece of the puzzle to give consideration to.

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