Is Inventory Included in the Valuation and Sales Price?

For many experienced Business Intermediaries, this is not the first time this question has been asked. While most valuation and recasting elements of our profession are very straightforward, how inventory is incorporated in a valuation and business sale varies considerably. This is an issue where the phrase “it depends” is appropriate.

The guidelines and considerations for addressing inventory can be different depending on the industry, type of business, and amount of inventory involved when both valuing and selling a business.

In asset sale transactions, the most common structure is for the seller to retain cash & accounts receivable, satisfy accounts payable and transfer all assets free and clear of any liens/encumbrances as of the day of closing. The buyer typically acquires all assets necessary to operate the business and these are normally included in the multiple of adjusted earnings derived through the Income Approach valuation method. Valuing a business via a multiple of adjusted cash flow has little relevance unless it is accompanied with a breakdown of those assets which are included in the sale. Setting aside for now, those industries where inventory is significant in terms of value (jewelry stores, automobile dealers, grocery, liquor, etc.), a buyer should expect to receive some component of inventory included in the transaction price. Ultimately, the formula and structure needs to pass a reasonable person test and business inventory can be a grey area for many practitioners in our industry. Determining what an average amount of inventory is for a particular business can be established through inventory reports, historical sales, and balance sheet data.

Lender financing is often utilized to fund acquisitions and in these situations it will be important for the transaction to cash flow for the buyer. For certain transactions, the value of inventory is very high in relation to the value of the business and it might be challenging for the buyer to cash flow the transaction if all inventory was included. A calculation for “excess” inventory may be warranted, where a normal amount is included in the multiple and an excess component is added to the purchase price.

When preparing a business for sale it is important to evaluate the numbers from the standpoint of the buyer’s post transaction cash flow analysis. Based upon historical cash flow, sales price, and amount being financed, can the proposed transaction enable a buyer to obtain financing based upon prevailing loan packages? The post debt service cash flow must be adequate for the buyer to live on. For some transactions the total amount requested to pay “for everything” could be untenable from a buyer cash flow perspective.

Selling a business involves a number of challenges and mitigating known obstacles upfront will provide an easier path for all parties to complete the transaction. Inventory should never be a stumbling block to closing a sale. For businesses where excess inventory is present there are a number of solutions available. A couple of examples, include:
• Seller consign the excess inventory to the buyer (pay as sold basis)
• Current owner sells off excess inventory prior to transaction. (Depending upon how this is executed, it could be potentially detrimental to the new business owner should products be sold at below market rates to established clients).

In a perfect world, brokers and sellers should be performing a comprehensive assessment of inventory before listing a business for sale. Understanding the quality of inventory under roof and determining if the quantity is in balance with historical sales are worthwhile exercises when evaluating a business for sale.

Determining the following ratios and inventory characteristics at an early stage will pay dividends down the road for all parties:
• Turn Rate – both historical to the business and a comparison to the industry.
• Number of SKU’s – understanding the top sellers and poor performers.
• Salable/Obsolete – damaged, seasonal, obsolete.
• Cost – prevailing market cost vs. cost on the books.

This assessment process enables all parties to have an accurate depiction of the key product sales and the appropriate inventory that should be held by the business. Performing this process early in the engagement enables all stakeholders (seller, buyer, lender) with time to make the logical decisions to correct any inconsistencies or develop solutions to handle excess inventory.

Lastly, there are a variety of industries that are valued differently, especially those that carry significant inventory. Some of the more notable examples include:
• Jewelry Stores
• Grocery
• (used) Motorized Vehicle Dealerships
• Liquor Establishments
• Large Apparel Stores

For brokers who have expertise in these markets, it is generally understood that not all of the inventory is included in the valuation multiple. In some cases, none of the inventory is a component. For these situations, it is acceptable for the inventory (some or all) to be added on top of the industry specific multiple used in the valuation. Discussing specific valuations is tangential to this article so it is advised that the traditional professional resources are utilized by the advisor to properly value these inventory intensive businesses.

It is clear that there are a myriad of considerations addressing the inventory issue in a business for sale. The goal of this article was not to provide a solution or valuation methodology for each industry or specific circumstance but to address some of the avoidable pitfalls related to this topic. Having a large inventory, in some cases, has clear logic behind it and advantages to the buyer, who acquires it. Performing an assessment of the inventory make-up, comparing with industry guidelines, and developing creative solutions to satisfy the goals of both the buyer and seller are recommended to achieve a successful transaction.

Negotiate Better With Better Questions To Combat A Bully – Negotiation Tip of the Week

Have you given thought to how you can combat a bully based on the questions you ask? A bully, in this case, can be anyone that intentionally attempts to intimidate you in any environment (you’re always negotiating). Questions posed to yourself before a negotiation and to a bully during a negotiation will impact the flow of the negotiation.

Consider thinking about the following questions before engaging a bully in and during a negotiation.

Questions to ask yourself:

I know the person I’ll be negotiating with has a reputation for being perceived as a bully when he negotiates. How can I change his demeanor before entering the negotiation? This question will help you focus on the strategy you’ll develop for the negotiation.

Why has the bully targeted me to negotiate with and what bullying strategies might he use in our negotiation? This question will give you insight into how the bully sees you. Based on the answers, you may have to do something to get the bully to alter his perception of you. From there, you can determine how to reposition yourself in the bully’s eyes to combat him.

What weaknesses does he sense in me? Having this insight before the negotiation will allow you the opportunity to strengthen your negotiation skills per the best negotiation strategies you can use to combat him.

Who else has he negotiated with as harshly as his reputation indicates he’ll do with me? Who has he not negotiated with as harshly and why did he adopt the approach he did with that entity? Having information about the bully’s past negotiation demeanor will allow you to understand who the bully fears and why. From there, you might consider allying yourself with that source.

Questions to ask bully:

Why are you projecting the type of negotiation behavior you’re emitting? This question will open a dialog between you and the bully. It’ll also put the bully on notice that you’re aware of his actions. Note any behavior change from this point.

Ask her, what’s the best outcome you’re seeking from this negotiation? All you’re attempting to do in this case is uncover any potential hidden agendas that she’s not put on the table. Once you have this insight, you can decide what adjustments you’re willing to make.

Another question is, do you have a problem with me personally or professionally? In her reply, she’ll disclose whether she has personal issues that emanate from her gender, ethnicity, or another source. Regardless of the reply, you will have gained additional insight as to the source of her motivation. If it’s something you can’t change (e.g. she doesn’t like your gender or ethnicity), you can let her know that’s an issue you can’t alter. Then, ask if she wishes to continue the negotiation in a more amicable manner. Either way, you will have let her know that you can become someone to contend with if she pursues the negotiation in which she’s doing.

Questions impact everyday life. In a negotiation, the right questions asked at the right time can enhance or detract from your negotiation position. In your future negotiations, give careful consideration to the questions you ask yourself and the opposing negotiator. In particular, consider asking questions that will have the greatest impact on the bully and those that will add the most value to your negotiation efforts. Doing so will better align you and your efforts for a successful negotiation outcome… and everything will be right with the world.

The Hidden Value of Trust In A Negotiation (DACA) – Negotiation Tip of the Week

When someone trusts you in a negotiation (you’re always negotiating), they’re more likely to believe what you tell them. Thus, there’s hidden value in trust when negotiating from a long-term perspective. Once trust is broken it’s difficult to regain it. Therefore, broken trust sets off negative ripples that can have unintended and unexpected consequences in the future.

Let’s look at the trust factor with DACA (Deferred Action for Childhood Arrivals) as an example. The kids in the DACA program were brought to the US by their parents. In most cases, they had no input as to whether they would stay where they were, or travel to the US. They instinctively trusted their parents with that decision. Then, there’s the US government.

The US government basically said, if you register for the DACA program and abide by our requirements (i.e. check in every 2 years and make payment to stay in the program, go to college, serve in the military, stay employed, pay taxes), you’ll be OK in the US.

Some registered and some didn’t. Those in the DACA program trusted the government and abided by their mandate. Then, trust was thrust out the window. Those in the DACA program cried, ‘We did what you asked of us! Why are you going back on your word? We trusted you!’ Those that did not register for the program, if not stated out loud silently thought, ‘see, I told you so; you should not have trusted them. The government can’t be trusted. Now, the information you gave them will be used against you.’ The ripple that such a message sent to non-DACA members was, stay in the shadows and let the darkness protect you.

In the eyes of those in the program, the US government went back on its word and broke the trust it had conveyed. Suffice it to say, the ripples set forth from this situation will cause the government not to be trusted in future matters by different entities. They’ll mentally relate their situation to the resemblance of the DACA plight. That means those submitting information requested by the government will be skeptical at best and cynical at worse when contemplating a course of action that they should adopt. In essence, through the loss of trust, the government has made it more difficult for others to trust it.

If I tell you the truth, will you believe what I say and trust me? If my perception of the truth is altered in the future, will I be declared a liar? If so, what will become of our future negotiation efforts? Those are questions every negotiator needs to consider before and during a negotiation. That’s the hidden force that trust has on a negotiation.

When trust is the foundation upon which a negotiation is built, the truth becomes a happier companion in the negotiation. Therefore, when the truth as one knows it shifts, the shifting of the truth can still have believability.

Change allows you to embrace new experiences, and everything changes. Thus, what’s true today may be proven not to be valid tomorrow. Nevertheless, once trust has been established and nurtured by consistency, over a period of time change can withstand the onslaught of doubt and suspension. In so doing, even when your negotiations become difficult, you’ll have less of a challenge finding a path to success, simply because you had trust adding hidden value to your negotiation… and everything will be right with the world.