Valuing a business with excess inventory and high working capital needs

October 06, 2023

by a searcher in Petaluma, CA, USA

Consider this overly simplistic example:

A stable (not growing) business with $10MM in Rev and $4MM in COGS. Inventory lead times are 6 months, and orders are being placed every quarter ($1MM each time). EBITDA = $2MM. Industry multiples of EBITDA are ~3x. Inventory on hand = $3MM of which $2MM will sell in 1 year and 1 MM in the second year.

How would you value this business as a buyer? How would an appraiser/bank look at it?

I think an appraiser/bank might say: Valuation = 3x EBITDA = $6MM + Excess inventory ($1MM) = $7MM.

Thoughts?

Reply by an intermediary
from Texas A&M University in Houston, TX, USA

You are looking at it in a reasonable manner. The key is seller being able to argue the excess inventory is grossly in excess. Otherwise if inventory levels are within industry norms then I don’t think you need to be paying the seller for the excess inventory. You might want to have the inventory appraised if it seems that this is truly grossly excessive inventory and the seller should get a payment for it,

Reply by a searcher
from University of Texas at Austin in San Jose, CA, USA

Assuming the business is able finance all its future inventory requirements, 7 is a decent price here, assuming 0% growth and 3x EBITDA exit in 5 years, IRR here would be 37%. This of course assuming, this a no cash no debt deal, Capex is minimal and working capital needs are not expected to significantly change in the near future. (I also assumed 500K in transaction costs, QofE, legal etc)

+2 more replies.

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