eCommerce Business Valuation Case Studies : Effect of Inventory on Valuation Multiple

In this series, I will discuss my experiences selling online companies for my customers and lessons learned.

Effect of Inventory on eCommerce Business Valuation Multiple

A while back I was selling an eCommerce company that had a great deal of inventory that had to be sold with the company. Typically stock values are in addition to the asking price of the company. You apply the valuation multiple to arrive at the asking price and include stock at cost in addition to the asking price. That’s the complete cash outlay buyer will need to make to purchase the business. Ideally, purchase of this inventory is non-negotiable product. There are two reasons for this. One — following the sale of the company, owner has no way of selling the stock and two — purchaser will require the stock to continue to run or expand the company. So normally selling an inventory together with the business is no problem. Things change however, when you have too much stock as compared to the asking price of the company.

If you believe from buyer’s standpoint, stock is a property that is dead. If I’m evaluating two companies for purchase, both with the identical profitability but one that’s a drop ship company and another which requires me to take inventory in addition to pick and pack to process orders, guess which company will I be choosing? On the other hand, there are some definite plus to getting an inventory in your warehouse as opposed to drop shipping. By way of instance, avoiding multiple drop ship fees for buyers that are ordering several items from a drop shipping eCommerce shop coming from another vendor, low margin and control over shipping etc to name a few.

So, how can value of stock affect the asking price of the company and is there an perfect quantity of stock beyond which it starts hurting your sale procedure? There’s no”one size fits all” answer to those questions but after real use case followed by a few factual data might offer some clue. If you’re new to the notion of eCommerce business evaluation, you may want to read my prior post on this subject here.

When this subject online company was initially recorded, list price of the business was at 3.11x several”including stock” and 2.53x”without including stock”. Value of stock at the time of record was 23 percent of their asking price. We were challenged by many buyers saying that our price was too high. Upon many month of advertising and adjusting the price, we finally received multiple offers at valuation multiple of 2.21x including stock and stock value then was 36 percent of their asking price. Allowed no two businesses are alike and those amounts could have been completely different for another business, I’ve seen again and again that seller that are selling businesses with greater quantity of stock than usual ends up getting lower offers. Stated inversely, I also have seen that companies that have lower quantity of inventory will probably receive complete price offers when recorded at a reasonable market value.

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Here are some observations from five real eCommerce businsess transactions within earnings Assortment of 500K to two million:

  • Most frequent Inventory levels in this group of companies were about 13 percent of earnings representing 7x inventory turnover annually
  • Most frequent Inventory value when represented as percent of asking price for same group of companies varied between 17 to 19%.
  • The best case example in the above mentioned group (ie lowest inventory level) had an inventory level that has been 2% of it’s annual earnings and turnover /year ratio of 35x. Inventory for this company was only 11 percent of asking price — providing this company a substantial advantage over it’s peers while at the marketplace.
  • Subject online business described above was one of those companies in this category that had the maximum inventory level.

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Based on many transactions I have been involved with, I can reasonably say that eCommerce companies with stock levels and asking price in the assortment of initial two bullets didn’t have harmful impact on the selling price (due to stock value) but as stock level rise, sellers might begin to see offers at reduced valuation multiple.