Today, I want to dive into a great question I received from Anton about evaluating a business and how inventory fits into the equation. Let's dive into it!
The Question:
When assessing a business, should the value of inventory be added on top of the multiple of cash flow in determining its overall worth?
Understanding Enterprise Value:
When we calculate cash flow multiples, we arrive at what's known as enterprise value. Enterprise value encompasses everything necessary to make the business operate efficiently, from machinery to equipment and more.
The Role of Inventory:
Inventory is a vital part of a business's operating capital, alongside assets like cash and receivables. However, how inventory is treated by lenders for collateral purposes depends on its nature.
Fungible vs. Non-Fungible Inventory:
Fungible Inventory (e.g., Lumber): Banks are more likely to lend against this type of inventory, considering it as security. It can be liquidated if needed.
Non-Fungible Inventory (e.g., Fashion): More challenging to finance due to its perishable or seasonal nature. Banks might be less willing to use it as collateral.
Net Normal Position in Working Capital:
The enterprise value already includes the net normal position in working capital. This refers to the amount of equity an owner typically needs to support working capital. It considers factors like inventory, receivables, payables, and the owner's cash.
Businesses that have been successful for a long time are often over-capitalized with working capital. What the current owner has done may be very different from how you’ll need to operate.
Asset Sale vs. Share Sale:
Asset Sale: The buyer acquires equipment, machinery, leaseholds, and inventory. The buyer must secure their line of credit to support the inventory since debts and lines of credit aren't transferred.
Share Sale: Inventory, payables, and receivables usually come with the company. Working capital adjustments are made during the transaction.
Implications for Buyers:
Fungible Inventory: In businesses with highly fungible inventory, a significant portion is likely added to the cash flow multiplier.
Non-Fungible Inventory: For businesses like produce stands or fashion boutiques, the entire inventory may be factored into the cash flow multiplier, as it can't stand as collateral for lenders.
Understanding the dynamics of inventory in business valuation is crucial. It impacts the negotiation process and the overall financial strategy for the buyer.
If you found this explanation helpful, you'll appreciate the in-depth case studies and insights in my online course.
In the world of small business investing, we try to separate operating businesses from real estate because the assets are different and are valued in different ways.
But what if the business IS Real Estate?
Marinas, campgrounds, Bed & Breakfasts, motels, etc?
What different considerations are in place and how do we know we’re making an offer that makes sense?
I’m happy to have Jaci join me on a live broadcast.
Jaci has decades of experience working with companies to craft the right branding and implement strategic plans to make sure this brand works its way into every level of the organization.
In particular, she’s worked with many small businesses through the Brand State U project.
Tune in and as we’ll be discussing rebranding after an acquisition, Strategic Branding Plans and Rebranding a Holdco.
This is a ‘must see event’ for small business owners and those with aspirations to become one.
Be sure to join live so that you can ask questions, replay will be available.
I remember a few years ago I had an interesting exchange with a viewer about a potential investment scenario that I believe could benefit many of you. Let's dive into it!
If you watch the video on YouTube, please hit the LIKE button. Old videos need new LOVE!
The Situation:
A viewer on the West Coast shared a unique opportunity. A friend is launching a startup, armed with a solid business plan and approval for a loan from a bank. The catch? The friend needs a certain amount of cash as equity to secure the loan.
Option A: Invest the Money
The startup entrepreneur approached the viewer with two options:
Loan $15,00 or-
Invest $15,000 in the business.
The Dilemma:
The viewer sought advice on the pros and cons of each option and how to secure returns.
Why I'm Not a Fan of Being a Minority Shareholder:
Business owners can manage finances in a way that leaves no net income for dividends, leaving minority shareholders with little return on investment.
The only way this might work is if the shares had some kind of defined preferred rate of return and without collateral, these are still risky.
Option B: Lend the Money:
Considerations:
Collateral: Does the entrepreneur have any collateral to secure the loan?
Interest Rate: Without collateral, think of yourself as a credit card. Be cautious and consider a higher interest rate.
My Advice on Interest Rates when putting your money into these kinds of deals:
For secured loans: Prime plus a few points.
For unsecured loans: Consider the risk and go for higher rates, similar to credit card rates.
Risk Mitigation: If possible, secure collateral for a Plan B in case the business doesn't succeed.
A Personal Touch: For more significant amounts, consider involving multiple investors to share the risk and responsibility.
Investing or lending to startups involves risk, and understanding your position is crucial.
Remember, the success of a startup depends on various factors, and having a backup plan is wise.
If you’d like to watch the video I made about this or download a 10 step checklist here:
Few years ago I remember I had a conversation with someone who had been diligently exploring the path to buying a business.
Their experience resonated with common challenges faced by many prospective buyers, and I thought I'd share some insights that might be valuable for you too.
If you watch the video on YouTube, please hit the LIKE button. Old videos need new LOVE!
Challenges Faced:
The individual shared two recurring hurdles in their attempts to buy a business
Significant Deposits and Detailed Financial Information:
Sellers consistently asked for substantial deposits as a demonstration of commitment. Simultaneously, they were pressed for detailed financial information, making negotiations complex.
Vendor Financing Resistance:
Attempts to discuss vendor financing were met with resistance, and they found it challenging to even initiate these conversations with sellers.
The First Sale - Selling Yourself as the Right Buyer:
The underlying issue was clear – the individual had not successfully made the first sale. When buying a business, it's not just about sellers presenting their product; it's about buyers selling themselves as the right fit for the business. This involves showcasing your capability, resources, and commitment.
Preparation is Paramount: Approach potential sellers with confidence by preparing thoroughly.
The Buyer Resume: Learn the importance of a buyer's resume in breaking down barriers and making that crucial first sale to the business owner.
Remember, the first sale isn't the seller convincing you to buy their business; it's you persuading them that you are the right person for the job.
Feel free to reach out if you have any questions or if you're ready to embark on this journey to business ownership success.