This is the second post in a series called “Valuing Your E-Commerce Business”. Click here to see all posts in this series.
Last week in this series, we discussed SDE and add-backs, but there is another crucial cost you should be compensated for when valuing your business: inventory. We’ll explain how you can accurately value your inventory, why you should invest in quality inventory, and what you can expect from your buyer’s LOI.
Inventory Valuation
If you’ve spent capital on inventory that a new buyer will get to profit from, it’s important to make sure you’ll be compensated for the value of that inventory in the sale of your business. You can think of this as the new owner buying the inventory from you during the sale.
You should value your inventory at your cost, or how much you paid for it without including advertising, packaging, or shipping costs. You’ll then add the total value of your unsold inventory to the total valuation after the market multiple is applied.
Quality Inventory
While you should get compensated for your purchased inventory, your buyer will harshly scrutinize the quality of your inventory. Buyers are reluctant to pay full price for inventory that isn’t moving, and they have the right to ask for a deduction for SKUs that they know they won’t be able to sell.
For this reason, it’s extremely important that you have two things in order in the months leading up to a sale: an optimized catalog of products and high-quality accrual accounting.
One of the most productive things you can do leading up to the sale of your business is to be ruthless in simplifying your product line. Take a hard look at your SKUs and throw out anything that’s not moving as it should be, anything with an extremely small margin, or anything that once was trendy that’s now gone out of style (more on how to spot underperforming SKUs can be found in this post). Presenting a potential buyer with a knockout list of products will increase the buyer’s confidence in the sale, as well as set you up for a better inventory repayment.
Aside from an excellent product catalog, an important element for valuing your inventory is solid accrual accounting. Having organized, investor-grade books will allow you to more easily assert the value of your inventory and back up your valuation claims with P&L data. If your business is in need of an accounting clean-up, contact us for a free discovery call today.
What to Expect from Your Buyer
After the valuation process, your buyer will present you with a Letter of Intent (LOI). This letter will outline the market multiple the buyer is willing to pay for the business, as well as a factor that includes the value of your inventory and working capital. This inventory factor provides accountability for you as the seller to continue to purchase high quality inventory in the months before the business is turned over to the new owner.
Next week, we’re diving into deal structure for e-commerce business sales. Check back for more in this series!