Inflation Storm - Selling Your Business Amidst Input Price Volatility

As a Baby Boomer, you remember the rampant price inflation of the late 1970s and early 1980s. Perhaps this was the time when you started your business. It was a different world back then. In fact it’s been so long that it feels like a dream, like something that might have never happened.

Fast forward to the present moment. The year is 2022 and the inflation nightmare is back. The official US government reported Consumer Price Inflation (CPI) is increasing at a shocking rate of 7.0%. After decades of being lulled to sleep by stable prices, you are being bombarded with price increases across the board. In many cases, these price increases are being paired with longer lead times than you’ve ever experienced.

If this inflation storm is the final stressor pushing you to exit your business, you’re not alone. It truly is a tumultuous time across several industries.

If your business is likely to be purchased by a Financial Buyer, as discussed in this previous article, your buyer, above all else, is risk averse. Therefore, the volatility in input prices, even though just a momentary blip, could be a cause for concern.

Despite your decades of stability, if you are seeing volatility in input prices it will likely hurt the valuation of your business, either through a reduced multiple assigned to your cash flows, or by reducing their projection of future cash flows to account for rising input prices.

What can you do to exit well in the midst of such a unique situation? 

Let’s discuss two actions you can consider taking.

1.Develop Ways to Stabilize Your Prices

In short, get creative.

Lock in your margins: If you are in a business-to-business market, it is possible that you may be able to secure material price adjustment agreements with your customers. These agreements utilize a known index and adjust prices periodically to account for changes in the underlying commodity price. Match your agreements with customers to your supplier agreements and your margins should be protected.

Use buying power: Another approach would be to have your customer procure the volatile raw material and consign it to you. In cases where you have a larger customer with more buying power, they may be able to secure a better price and more reliable supply. This often cuts into your ability to “mark up the material”, in return for securing more stable earnings. But the trade off might be worth it.

Make long-term commitments: Sometimes making long-term commitments to your suppliers is what is necessary. In return for a commitment to buy a certain amount of product over some period of time (rather than ordering simply as needed, i.e. spot orders), you may be able to lock in a stable price for a reasonable period of time.

2. Buffer Your Safety Stocks Where Practical

For most of our business lives we have become accustomed to holding less and less inventory. The world has been operating in seemingly perfect synchronization for decades with a few notable exceptions. That all changed in 2020 when everything stopped for a few months and then came back in fits-and-starts. The resulting chaos will still take years to work itself out.

A partial solution here is simple: hold more inventory. Yes, it will cost your precious working capital, but the return will be substantial when it comes to selling your business. When you sell your business, the most important factor will be your EBITDA. If you run out of material and your processes go idle, you will not be able to generate positive earnings. Remember that every dollar of EBITDA will receive a 4x, 6x, 8x, or 10x+ multiple depending on numerous factors.

So the one-time cost of holding additional inventory is up against the multiplicative impact of the EBITDA multiple.

If you’re getting ready to sell your business and you are going through some challenging changes in the economic landscape, you are going to need to tell a great story.

At Doescher Group, we help our clients prepare for and execute their exits with confidence and ease. A key part of telling a great story involves addressing potential pitfalls, and backing up our responses with data before the questions are even asked. If you’d like help identifying and addressing where your potential pitfalls are before you’re in negotiations, let’s connect to talk about an exit audit.