M&A Deal Killer Miniseries #4: Overvaluing Assets & Inventory
Overvalued assets could lead to several problems on even the sweetest M&A deal.
Making the decision to move forward with selling your business is a tough one – but also incredibly exciting! After years of building and growing your company, the time has come for you to begin working on an exit strategy that will benefit you, your business and your future lifestyle. While exploring different exit options may feel daunting, just know that you are not alone and this is a normal phase in the small business life cycle. The best way to ensure that you plan a successful exit is to do your homework ahead of time, evaluate the risks and assess any weak spots in your business. We also highly recommend building an advisory team that includes a CPA, attorney and a professional business broker to ensure that your best interests are always on the forefront of the deal.
During the research stage, it’s important that you investigate how to ensure you have a successful transaction and get the best price possible for your business. But at the same time, it’s critical that you examine the potential deal killers as well. Having a deal fall apart at the last minute is every business owner’s nightmare and if you take the time to explore what could go wrong, you have time to work on reducing risk. One of the biggest deal killers for any M&A transaction is overvalued inventory. Overvaluing your inventory can lead to several issues during the due diligence stage, including repricing the business, canceled offers and much more. If you think you may have overvalued your inventory or you are getting ready to have it appraised, we have outlined a game plan below to ensure you can correct the issue and smoothly close on your business.
What are the risks of inflating the value of my inventory?
Correctly calculating value during the sale of a business is critical, especially when selling to a third-party buyer. Business value is determined based on several factors and when inventory is overvalued, it opens a window for the buyer to renegotiate the deal. To correctly appraise inventory and assets, you should only include items that are used in normal, recurring business operations but be sure not to leave anything out either. If your inventory or assets were overvalued and a buyer was to find out, here are the potential risks:
- The buyer may try to reprice the deal or even rescind their offer, forcing the seller to restart the entire transaction process.
- If the buyer were to find out after the deal is closed, they may attempt to take legal action against the seller.
- Offers on the business may come in lower than the actual value as the buyer (and their lender) will try to account for the discrepancy.
- Banks may only approve funds for the buyer at an amount lower than the actual price of the business.
How can I determine if my assets are priced higher than they are worth?
The first step to identifying a problem is understanding how to accurately determine the value of inventory and assets. Like we mentioned before, its essential that you only include assets in the valuation that are used in everyday operations. The reason behind this is that businesses are valued based on cash flow and your assets are viewed as tools for creating revenues and profits. Buyers view these important items as the means for repaying their loans, as does the lender, who obviously has a vested interest in getting that loan paid off. If you have noticed items in your inventory list that are not used regularly, you may want to consider re-evaluating the inventory value. It’s also important to look at the dollar figure placed on each item; is that original cost or replacement cost? After digging deeper, if you find that your equipment may be incorrectly appraised, you may want to consider getting a second opinion to ensure the deal remains strong down the road.
My inventory is overvalued – how can I properly adjust it down?
So, you’ve discovered an issue with the way your inventory was valued – don’t worry! There is still time to fix this problem and ensure a smooth M&A transaction for your business. The first step to reflect on why and how your equipment was valued; depending on the reasons, some of the numbers may be off. We’ve listed a few examples below of instances that may affect just how your equipment was valued and why there may be an inaccuracy.
- The assets may be valued at replacement cost versus original cost, which could be higher. If you have had your equipment appraised previously for insurance purposes, this might be a good starting point if you are looking to adjust the value.
- If you have previously had your equipment valued for banking purposes, such as applying for a loan, the assets may have been valued as collateral. Valuing equipment so that you can secure a larger loan may have inflated the numbers.
- You may have also had your assets valued for tax purposes, and in this case, they may have been appraised at cost the depreciated over time. This method would deplete the value of your assets and lower the total value of your inventory. Even with a straight-line depreciation schedule, most equipment has no book value after five to seven years.
How can I ensure the rest of my business transaction runs smoothly?
The answer to this question can be summed up in two words – presale planning. Selling your business is like any other major milestone you will experience in life; you need a solid plan with implementation. There are several moving parts in the business sale process and properly valuing your inventory is just one of them. It’s important to remember that everything about your business comes out during the due diligence phase and it would be terrible to have a deal fall apart because of something you could have easily fixed months prior to listing the business. To catch these types of weaknesses, we recommend meeting with a professional business broker to 6-12 months prior to selling. With the help of a professional, you can identify any potential issue and they should be able to offer up some advice on how to resolve it. With a solid presale plan, it is feasible for you to maximize your proceeds from the sale and achieve a prosperous liquidation of assets and inventory. The goal is to maximize the value of your business so that you can benefit at closing and with a proper plan, you can have multiple liquidity events in addition to the business sale.