In this series, I will share my experiences selling online businesses for my clients and lessons learned.
Effect of Inventory on eCommerce Business Valuation Multiple
Some time ago I was selling an eCommerce business that had a large amount of inventory that needed to be sold with the business. Typically inventory values are in addition to the asking price of the business. You apply the valuation multiple to arrive at the asking price and add inventory at cost on top of the asking price. That is the total cash outlay buyer will have to make to buy the business. Ideally, purchase of the inventory is non-negotiable item. There are two reasons for that. One – after the sale of the business, owner has no means of selling the inventory and two – buyer will need the inventory to continue to operate or grow the business. So normally selling an inventory along with the business is not an issue. Things change however, when you have too much inventory as compared to the asking price of the business.
If you think from buyer’s perspective, inventory is a dead investment. If I am evaluating two businesses for purchase, both with the same profitability but one that is a drop ship business and the other that requires me to carry inventory as well as pick and pack to process orders, guess which business will I be picking? On the other hand, there are some definite plus to having an inventory in your own warehouse as opposed to drop shipping. For example, avoiding multiple drop ship fees for buyers who are ordering multiple items from a drop shipping eCommerce store coming from a different vendor, low margin and control over delivery etc to name a few.
So, how does value of inventory affect the asking price of the business and is there an ideal amount of inventory beyond which it starts hurting your sale process? There is no “one size fits all” answer to these questions but following actual use case followed by some factual data might provide some clue. If you are new to the concept of eCommerce business valuation, you might want to read my previous post on this topic here.
When this subject online business was first listed, list price of this business was at 3.11x multiple “including inventory” and 2.53x “without including inventory”. Value of inventory at the time of listing was 23% of the asking price. We were challenged by many buyers stating that our price was too high. Upon many month of marketing and adjusting the price, we finally received multiple offers at valuation multiple of 2.21x including inventory and inventory value at that time was 36% of the asking price. Granted no two businesses are alike and these numbers could have been totally different for a different business, I have seen time and time again that seller who are selling businesses with higher amount of inventory than usual ends up receiving lower offers. Stated inversely, I have also seen that businesses that have lower amount of inventory are likely to receive full price offers when listed at a fair market value.
Here are some observations from five actual eCommerce businsess transactions within revenue range of 500K to 2 million:
- Most common Inventory levels within this group of businesses were about 13% of revenue representing 7x inventory turnover per year
- Most common Inventory value when represented as % of asking price for same group of businesses varied between 17 to 19%.
- The best case example in the above group (ie lowest inventory level) had an inventory level that was 2% of it’s annual revenue and turnover /year ratio of 35x. Inventory for this business was only 11% of asking price – giving this business a significant advantage over it’s peers while in the market.
- Subject online business described above was one of the businesses in this group that had the highest inventory level.
Based on many transactions I have been involved with, I can reasonably say that eCommerce businesses with inventory levels and asking price in the range of first two bullets did not have detrimental effect on the sale price (due to inventory value) but as inventory level rise, sellers may start to see offers at lower valuation multiple.