Valuation of backorder?

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September 20, 2021

by a searcher from Harvard University - Harvard Business School in Portland, OR, USA

I am currently negotiating a deal with a seller for a sales and distribution business. The 2021 EBITDA is projected to be ~$1.5M, up from $1M in###-###-#### Due to widescale supply chain disruptions, the seller has quite a bit of backorder buildup which he wants to include in addition to the EBITDA valuation. His logic is that if it hadn't been for the supply chain disruption, then his EBITDA would be even higher and he should get paid for that.

He estimates his sales backlog at end of year will be about $10M (typically it's around $3M). So he surmises that $7M of that backlog is excess and would have translated to EBITDA. He typically has a net income % of 6-8%, so he thinks that taking 5% of the backlog value is conservative and reasonable. 5% of $7M at a 5x multiple = $1.75M. He is proposing that we add an additional $1.75M onto the purchase price.

Has anyone ever dealt with valuing backorder?

This seems to be an abnormal event caused by the current global supply chain challenges. My initial reaction is to not value the excess backorder the same as EBITDA as it's not even AR and the orders could potentially be cancelled. But the seller is pushing for a backorder adjustment to the valuation, since by his logic, EBITDA would be well over $2M if the supply chain were normalized.

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commentor profile
Reply by a professional
from Lakeland College in Green Bay, WI, USA
Coming from a valuator's standpoint, I have been seeing a lot of business owners who have been able to be overly successful from the COVID pandemic trying to get above average multiples and higher values based on higher than normal business activity. Yes, they did well but would they have been able to do that volume without COVID? Probably not. I would agree with the previous comments that there are a number of other things to consider as to whether or not these back orders will be fulfilled. Capacity, supply chain resolution, margins, Working Capital, strength of the customer relationships, etc. If the seller has a plan in place to mitigate a lot of this risk and be able to continue running the business at the same levels (has an actual thought out proforma showing this) then I would consider placing the extra $$ in some form of earnout. They are already benefiting from the increased EBITDA this year. I'm not convinced with the information provided that there is a high likelyhood that the backorders will be fulfilled post sale.
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Reply by a searcher
from Harvard University in New York, NY, USA
Don't pay that that amount extra.

a) It also sounds like you're already paying for a peak year price based on the $1.5M EBTIDA.
b) This doesn't sound like a recurring increase. At most, it would need to be multiplied by 1 over the purchase multiple.
c) However, fulfilling 3.3x as much back-order as normal seems to have already broken the business -- he was unable to fulfill the back-orders (even if the reason was "supply chain").
d) That plus the fact that the back orders may never be fulfilled (and if they are fulfilled, might impair future normal business performance).
e) I'm really not sure outside-in if the margin profile is the same for those backorders. Costs increased for many things in the supply chain disruption. If his sale price is fixed and his cost price is not, then all that backorder is a liability and not an asset

Maybe you shouldn't get the back-order for free. But it's an earn-out thing, not a cash up front thing
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