Published June 28, 2011

Inventory Not Sold Separately

By Paul Wormley

I spent some time today explaining to an entrepreneur why inventory is not sold separately in the sale of a small business. His proposal involved selling his business for $4.0 million and selling his inventory for an additional $2.0 million – a total of $6.0 million.

For Hadley Capital, and most buyers, the value of a business is determined by its ability to produce sustainable, operating cash flow. A business produces cash flow by converting tangible assets like inventory and intangible assets like intellectual property into salable products and services.

In this case, the business was using $2.0 million in inventory (and other assets) to produce $1.0 million +/- in annual cash flow.  I valued the business, based on its cash flow, at around $4.5 & $5.0 million.

Alternatively, I offered to value the business based on its assets. The business had a net book value of around $3.0 million, which includes the inventory and all other assets less certain liabilities.

The business owner obviously liked $4.5 & $5.0 million better than $3.0 million but still had a hard time appreciating why we wouldn't buy the inventory assets separately.

I gave him an extreme example to try to drive home my point regarding assets not being sold separately:

Suppose you operate a consulting firm instead of a manufacturing business. Your consulting practice has intangible assets including its workforce (consultants) and intellectual property (consulting models). You spent money to develop these assets and these assets generate cash flow & just like inventory in a manufacturing business. Are the consultants sold separately?

PDW

P.S. We have a pretty vanilla overview of how Hadley Capital values small businesses on our website.

Paul Wormley - General Partner

Paul joined Hadley Capital in 2005. He has spent his entire career working with small and emerging companies. Paul grew up in a family business environment and is an owner of his family’s community newspaper business. Paul works with GT Golf Supplies, Pneu-Con, Open Sky Media and Centare. He was the chairman of the board of directors for i-deal Optics, a previous Hadley Capital company.

Paul is an outdoor enthusiast who enjoys fishing, hunting, riding motorbikes, Crossfit and an occasional craft beer. He works closely with a number of non-profit organizations including One Acre Fund and Trout & Salmon Foundation, and serves as chairman of the Finance Committee at his church.

Paul is a graduate of the University of Colorado at Boulder and received an MBA from the Kellogg School of Management at Northwestern University. He and his wife, Rosemary, have three children.