I interviewed Dirk Armbrust who discussed How Supply Chain and Inventory Issues Impact M&A.
It's great to speak with you today, Dirk. And I’m looking forward today to hearing your views on how supply chain and inventory issues impact merges and acquisitions' transaction value.
It's great talking to you too, Dustin.
Great. And my first, can you first provide a brief background of yourself?
Sure. I'm with the Van group, we're a mergers and acquisitions advisory firm here in Dallas, Texas. We specialize with merges and acquisitions in the small and medium business space and also the lower end of the middle markets. So what does that mean? We handle businesses with revenue size from $1 million to $25 million in revenues. We handle M&A transactions on the buy side and the sale side. We do business evaluations, we help raise capital for growth or acquisitions and we also have an operations consulting practice. Mostly targeted when helping businesses get ready for sale on the operating side or for just running their business and growing it, things of that nature. My background, I've been in the M&A transaction space for about five years. But part of that, I had a 20 year career in operations starting out in supply chain and materials with Dell computers in Austin, Texas. Then had my own manufacturing business, moved over to International Paper as a plant manager in the International Paper's distribution business. And then I privately held industrial packing company doing heavy crates and packaging a supply chain solutions for manufacturers here in the United States and then also spent some time as a market manager running 120 stores for 7/11. So my background is a little interesting in the fact that I've done a number of operating type roles and seen how inventory impacts the success of the businesses. And now being in the M&A transaction space, being able to bring that perspective of how supply chain issues, inventory, and things of that nature can impact M&A transactions.
Thanks and well what problems do you see with inventory in relation to M&A?
There are a ton of opportunities and issues associated with it. So first off, think about it. In an M&A transaction, somebody is buying a company whether it's another company doing a bolt on acquisition. Whether it's a private equity group requiring a company or whether it's an individual leaving the corporate world and wanting to dip their feet in the entrepreneurial waters and buying a company. What they're looking for is a company that has processes in place, that is well run, and things are smooth. So what does that mean on the supply chain side? Normal do diligence of anyone acquiring a company, they're going to look to see is the supply chain healthy and strong? Are there processes in place to ensure things like continuity of supply, quality of supply? Now, M&A transactions are financial transaction. So the impact of the supply chain on networking capital is something that's going to be looked at. So if you're seeing a company where you have one very large supplier, where you're the smallest customer of that supplier and they're really pressing you for really strict payment on delivery and things of that nature. And then you have customers that aren't paying for 30, 60, or 90 days. That business is having to carry that cash collection coverage and that will impact the sell ability and value of the business. The other thing that will impact it is inventory. All of us grew up thinking that inventory is an asset and it typically is and it's no different nowadays. But one of the things that impacted me was being in inventory management with Dell Computer Corporation. At that time we had three days’ worth of inventory. Inventory was actually a four letter word. It was inventory is an asset but the more inventory we had, the worse the situation is. That hasn't changed. It spans various industries, whether it's retail, whether it's manufacturing. The value of the inventory can impact an M&A transaction. So let's try a couple examples on the extreme. If inventory is a fairly low amount in terms of the overall value of a business, it very rarely enters the evaluation question. If inventory is large, a large percentage it can move the needle in favor of the seller or in favor of the buyer. And once inventory gets large, it requires an extra degree of scrutiny and that do diligence when somebody's looking to buy a business. If there's a high level of inventory, yep, great, you have networking capital that you need to grow and continue to run the business but how much of that inventory is obsolete? Anyone whose lived in a warehouse environment kind of knows what tricks to look for to see if inventory is healthy and fresh and new or obsolete. Are there multiple stickers on the boxes from the past three or four years? Those types of things.
Can you talk more about how these issues impact M&A transaction value?
Sure, exactly. Let me give you an example of a client we have today. Like I said, we work in the small and medium business space as well. This client has a distribution business. They distribute auto parts and truck accessories to retailers. So he's got one level upstream from the actual retail locations. Multiple customers, everything’s good, no supplier concentration issues. The seller is hoping to net $5 million. Like I said, we're in the small and medium business space. Justifying maybe in the upper $3 million almost $4 million. So we were talking to him in terms of how he can get to that value to get to that $5 million sale price that he's looking for. Or we turn to inventory. He has over $1.5 million in inventory. So we dug deeper into that next level. For a seller on the surface they're going to think, geez I get credit for all that inventory, right? Well not so fast because a buyer coming in, they're not going to know if that inventory's current, if any is absolute. But because that business, the inventory is such a clear story for what is needed for the operations of that business and because of the records that he keeps of his inventory, and even spot checking the inventory, if a buyer were to do that they would see that everything is categorized right, inventory control procedures are in place, all the payables are being managed, all the processes are in place, so he's absolutely able to get credit for that.
And what should be done to address this issue?
For any seller of any company you should look at all your processes, all your procedures and whether it's manufacturing, whether it's payroll...the more a buyer is able to walk in and see clean, clear, crisp processes and inventory is no exception, the better the sale's going to go for the seller. So things that your listeners probably know about good inventory disciplines, accurate accounts, fairly regular cycle program where high volume inventory is counted more frequently than more volume inventory. Inventory control procedures, the accounting is being taken care of. Old inventory is aged out appropriately and reserves or maintains on the balance sheet. When the buyer comes in and sees those disciplines in place, they're going to be more confident in terms of making a purchase of that business. Inventory may not necessarily impact the sales price of the business, the buyer may agree that the price the seller is looking for in the business is a fair price to pay for the business. However, the more questions the buyer is having to ask and having to answer, the more uncertainty is delivering into their process. And inventory is one of those things that if you're running, if there’s going to be a ton of questions a buyer is going to have about the business, try not to set it up where they have questions about those things. Because when buyers have questions about businesses and processes, the way that manifests, maybe not in the sales price, but in the terms. So there may be less cash at closing that the seller is going to get. The buyer may ask for more participation on a seller's part in terms of either seller financing or seller note, or earn out to where the seller's compensation is paid over time, depending on the performance of the business, in areas like a resort.
And do you have any examples of success?
Sure, that example I just told you about with the auto parts distribution business is a great example of success. Because like I said, sellers will often assume that the buyers are going to give them absolute credit for all parts of the networking capital equation. Give them credits for 100% of the accounts receivable and for 100% of the inventory. Buyers are often in no mood to give clear, clean credit for those types of things but this guy because he had the processes in place, the inventory level connected with the story of how he goes to business, absolutely success story.
Well thank you, Dirk for sharing today on this topic.
My pleasure, I enjoyed it.
About Dirk Armbrust
Managing Director at The Vant Group
Dallas/Fort Worth Area Marketing and Advertising