Question on how high raw material costs calculate into Multiple

September 17, 2024

by a searcher from Sophia University in The Woodlands, TX, USA

Hi all,
I'm looking at acquiring a $4 mil business with an additional $1 mil inventory that is primarily Raw Material and about 15-20% WIP.
Seller wants to sell inventory at value as part of the sale, but in addition to the business price..

Curious, when calculating a multiple, do you all calculate both the numbers?
So.... $800k SDE on $5mil total, (making it a 6.25 X multiple)? Or is there some magical equation whereas multiples exclude the Inventories, making it a 5X ($800k on $5mil)?

Thanks in advance~ appreciate it!

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Reply by a searcher
in United States

I agree with both Brads - they are spot on. To add to what they said, I think it is helpful to think of the inverse of the multiple: the ROI. If you pay 4x, you are getting a 25% return (1 / 4). The higher the multiple, the lower the return. If you need to invest more money to acquire the inventory, it is effectively raising your multiple and lowering your return, so you need to determine if that is acceptable.

And, as Brad K noted, you want "gas in the tank." Think about it this way: if a bank offered to sell you a CD that earns 5% per year, but then said - "oh, by the way, in addition to the $1000 deposit for the CD, you also need to pay us $25 so that we can generate the certificate and send it to you," how would you feel/react? It's not quite the same because you may get your investment in inventory back (e.g., if you sell the business or can lower inventory through better management). But it might be helpful to think about it from that standpoint ... if the inventory is the "right level" and you intend to hold on to the business, you've effectively decreased your ROI (which, again, may or may not be ok - if you are paying top price as it is, it's probably not ok).

And the risk around inventory can be significant. If the inventory gets stale quickly, this risk can be significant. It doesn't sound like your inventory will be out of date quickly, but you'd want to diligence the value to be sure.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I concur with Brad Kelly above. If you are paying the max multiple for a business, then you should get the business with the working capital build in. For an inventory heavy business, often that inventory is part of the working capital. If you have to buy the inventory on top of the business, then you would want to reduce the multiple so the numbers still cash flow.

Also keep in mind you want to be cautious about buying stale / out-dated inventory. If they have inventory that has not turned in a long-time, you might not want to buy that. You can also do a consignment of inventory, where they keep a portion of it but you have control and as you sell that inventor you pay them for it at cost. This really only works if there is good margin in the inventory so you still have the cash flow to cover operations and to replace the inventory.

If you need help assessing a specific deal, we provide a free review from a lender standpoint. You can reach me here or directly at redacted

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