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