The Valuation Multiple Is Only Part of the Price
When a distribution business owner starts thinking about a sale, the conversation usually begins with EBITDA.
“What multiple could I get?”
That is an important question.
But for a distribution company, there is another question that can have a significant impact on the amount the seller actually receives:
How much working capital will the buyer expect to be in the business at closing?
Distribution businesses are different from asset-light companies. A distributor needs inventory to fulfill orders. It needs accounts receivable to support customer terms. It relies on supplier credit and accounts payable to keep the operating cycle moving.
The buyer is therefore not simply acquiring earnings.
The buyer is acquiring a business that needs a certain amount of capital to continue producing those earnings.
That is why inventory and working capital can become a major valuation issue in distribution M&A.
If you are beginning to evaluate your company’s worth, Horizon’s Distribution Business Valuation resources provide a useful starting point for understanding how buyers assess the sector.
A $15 Million Valuation Does Not Necessarily Mean a $15 Million Check
Consider a simplified example.
A distributor generates:
$2 million normalized EBITDA
The buyer and seller agree on a:
6× EBITDA multiple
That produces:
$12 million enterprise value
The seller may naturally think:
“My business is worth $12 million.”
But enterprise value is not necessarily the same as the final equity proceeds.
The transaction may also account for:
- Cash
- Debt
- Normalized working capital
- Other debt-like items
- Transaction-specific adjustments
Working capital becomes particularly important because the buyer expects to receive a business that has enough operating assets to function normally immediately after closing.
If the company is delivered with materially less working capital than agreed, the buyer may not accept the $12 million headline number as the final economic value.
This is where the working capital peg becomes important.
What Is Working Capital in an M&A Transaction?
At a basic level, working capital represents the operating capital tied up in the company’s day-to-day business.
For a distribution company, the major components often include:
Accounts receivable: Money customers owe the business.
Inventory: Products purchased and held for resale.
Accounts payable: Amounts owed to suppliers.
Other operating current assets and liabilities may also be included depending on the transaction and the negotiated definition.
The important point is that not every balance-sheet item automatically belongs in the working capital calculation.
Cash and debt, for example, are commonly treated separately in a cash-free, debt-free transaction.
The precise definition is negotiated as part of the transaction documents.
That definition matters because it ultimately affects the purchase price adjustment.
Why Inventory Matters So Much to a Distributor
Inventory is not simply an asset on the balance sheet.
It is part of the engine that generates revenue.
But buyers do not necessarily value every dollar of reported inventory at face value.
They want to know:
Can it actually be sold?
How quickly does it turn?
Is it current?
Is it obsolete?
Was it purchased for a specific customer?
A distributor carrying $5 million of inventory can therefore have a very different risk profile from another distributor carrying the same amount.
Healthy inventory
Buyers generally become more comfortable when inventory demonstrates:
- Consistent turnover
- Strong historical demand
- Limited obsolete stock
- Reliable inventory records
- Appropriate purchasing discipline
- Predictable replenishment
Problematic inventory
Concerns arise when the balance includes:
- Slow-moving SKUs
- Obsolete products
- Damaged inventory
- Customer-specific stock with uncertain demand
- Excess purchasing
- Large unexplained inventory increases
The issue is not simply how much inventory exists.
It is how much economically useful inventory the buyer is actually receiving.
That distinction can become important during due diligence and at closing.
The Inventory Number Buyers See May Not Be the Number They Trust
Suppose a distributor reports $4 million of inventory.
On paper, that looks straightforward.
But imagine that $700,000 consists of products that have not moved for more than a year.
Another $300,000 was purchased for a customer program that has now ended.
The reported inventory may still be $4 million.
The buyer’s economic assessment of that inventory could be very different.
This is why buyers often request detailed inventory aging and SKU-level information during due diligence.
They are trying to determine whether the balance sheet represents real operating value or capital trapped in inventory that may eventually require a write-down.
For a seller, discovering this problem after an LOI is signed is far less attractive than identifying it 12 to 24 months earlier.
Inventory Turns Can Tell a Buyer More Than Inventory Value
A sophisticated buyer will not simply ask:
“How much inventory do you have?”
They may ask:
“How efficiently does the company convert inventory into sales?”
Inventory turnover provides useful context.
A business with disciplined purchasing and strong product velocity can generate significant revenue with a relatively efficient inventory investment.
Another distributor may require much more capital to produce the same revenue because inventory sits longer before being sold.
That difference affects cash generation.
And buyers care about cash generation.
This is one reason inventory management can become an important part of distribution company valuation, even when inventory itself is not the primary subject of the transaction.
What Is a Working Capital Peg?
The working capital peg is essentially the agreed level of normalized working capital that the buyer expects the seller to deliver at closing.
Think of it as a baseline.
The buyer is saying:
“The valuation assumes this business is delivered with the normal amount of operating capital required to run it.”
The seller and buyer then agree on how that normal level should be determined.
A common approach is to analyze historical monthly working capital, often over a trailing twelve-month period, while considering seasonality and unusual events.
The exact methodology is negotiated as part of the transaction.
That matters enormously for seasonal distribution businesses.
A distributor may naturally carry much higher inventory during certain periods of the year.
Using one arbitrary month as the benchmark could therefore produce a misleading result.
The objective is to establish normalized working capital, not an artificially high or artificially low number.
How the Working Capital Adjustment Can Change the Purchase Price
Consider a simplified transaction.
The agreed working capital peg is:
$2.0 million
At closing, the business delivers:
$1.7 million
The shortfall is:
$300,000
If the transaction documents provide for a dollar-for-dollar adjustment, that shortfall can reduce the seller’s purchase price by $300,000.
Now reverse the situation.
The business delivers:
$2.3 million
That is $300,000 above the agreed peg.
Depending on the negotiated terms, the seller may receive the benefit of that excess.
This is why the working capital peg is not merely an accounting exercise.
It can directly affect the seller’s proceeds.
For a distribution owner preparing for a sale, this is one reason M&A due diligence should not be treated as something that begins only after an LOI. Understanding the likely buyer questions before going to market gives the seller far more control over the process.
The Most Dangerous Mistake: Trying to Manufacture Cash Before Closing
A seller may think:
“Why not reduce inventory before the sale and collect as much receivables as possible?”
Or:
“Why not delay payments to suppliers and keep more cash?”
The problem is that the buyer is evaluating whether the business has been delivered in its normal operating condition.
If working capital is artificially reduced before closing, the buyer may identify the change and adjust the purchase price accordingly.
The seller may create short-term cash while simultaneously creating a purchase price adjustment.
The objective should therefore not be:
“How do I minimize working capital?”
It should be:
“What is the normal working capital requirement of my business, and can I demonstrate it?”
That is a much stronger position in an M&A negotiation.
Accounts Receivable Matters Too
Inventory often gets most of the attention in distribution, but accounts receivable can be equally important.
A distributor may show $3 million of accounts receivable.
The buyer will want to know:
How much is actually collectible?
A healthy receivables balance generally has:
- Consistent payment behavior
- Clear customer terms
- Limited aged balances
- Strong collection history
- Proper reconciliation
A balance containing significant overdue or disputed invoices creates a different picture.
If customers are routinely paying much later than their contractual terms, the business may require more working capital simply to support the same level of revenue.
That can influence the buyer’s assessment of the business.
Seasonality Can Make the Working Capital Discussion More Complicated
Distribution businesses often experience seasonal demand.
A company may build inventory before its busiest selling period and then reduce inventory afterward.
That creates a problem if the parties use an inappropriate measurement period.
Imagine a distributor that normally requires $2 million of working capital but carries $3 million during its peak season.
If a buyer proposes a $3 million peg based on a single peak month, the seller could be delivering significantly more capital than the business normally requires.
Conversely, a peg based on an unusually low working capital month could leave the buyer underfunded after closing.
This is why experienced M&A advisors analyze the historical operating cycle, not just the balance sheet on one date.
Inventory and Working Capital Can Affect Valuation Before the LOI
It is a mistake to think working capital only becomes relevant after a buyer has made an offer.
Experienced buyers consider it earlier.
Why?
Because working capital affects the amount of capital required to operate the company.
Suppose two distributors each generate:
$2 million EBITDA
But:
Distributor A requires $1 million of working capital.
Distributor B requires $3 million.
The companies may have identical EBITDA.
But the buyer needs substantially more capital to support Distributor B.
That can affect the attractiveness of the acquisition and the buyer’s return calculations.
This is one reason EBITDA alone does not tell the complete valuation story.
For a deeper explanation of how buyers distinguish EBITDA from the underlying economics of a business, Horizon’s EBITDA Explained: How Buyers Value Your Business provides additional context.
What Sellers Should Review Before Going to Market
If you are considering selling a distribution business, several areas deserve attention well before buyers arrive.
Inventory
Understand:
- Inventory aging
- Inventory turns
- Obsolete stock
- Slow-moving SKUs
- Seasonal patterns
- Purchasing trends
Receivables
Review:
- Aging
- Collection history
- Customer payment behavior
- Disputed balances
- Credit policies
Payables
Understand:
- Supplier terms
- Payment patterns
- Aged payables
- Unusual payment timing
Working Capital
Analyze:
- Monthly historical balances
- Seasonality
- Normal operating requirements
- Unusual fluctuations
- Potential working capital adjustments
This analysis gives an owner a much clearer picture of what a buyer is likely to see.
The Goal Is Not to Have the Lowest Working Capital
This is an important distinction.
Some owners believe that a lower working capital requirement automatically means a more valuable company.
Not necessarily.
A distributor needs enough inventory to serve customers.
It needs enough receivables capacity to support its sales terms.
It needs supplier relationships that allow the operating cycle to function.
The objective is efficient working capital, not artificially low working capital.
A business that can generate more revenue with less capital tied up in inventory and receivables may be attractive.
But a business that underinvests in inventory and constantly loses sales because products are unavailable may be destroying value.
Buyers understand this difference.
Operational improvements can therefore create value beyond simply increasing EBITDA. Horizon’s analysis of how operational efficiencies can drive higher M&A multiples explores this broader relationship between operational quality and buyer perception.
What Buyers Really Want to See
A sophisticated buyer wants a distribution company where the relationship between:
Revenue
Inventory
Receivables
Payables
and
EBITDA
makes economic sense.
They want to see a business where the balance sheet supports the earnings rather than constantly consuming cash.
That creates confidence.
And confidence is valuable in an M&A transaction.
The strongest distribution businesses are not necessarily those with the lowest inventory.
They are the businesses that demonstrate disciplined inventory management, predictable working capital requirements and reliable cash generation.
Prepare the Balance Sheet Before You Prepare the Business for Sale
Most owners naturally focus on increasing EBITDA before a sale.
That is understandable.
But for a distribution business, the balance sheet deserves the same attention.
A stronger EBITDA story combined with:
- Clean inventory
- Collectible receivables
- Normalized working capital
- Efficient inventory turns
- Reliable reporting
creates a much more credible acquisition opportunity.
The buyer can see not only that the business earns money, but also how efficiently that money is generated.
And that distinction can matter when negotiating the final economics of a transaction.
Frequently Asked Questions
How does inventory affect distribution business valuation?
Inventory affects valuation because buyers need to determine whether the reported inventory is saleable, current and sufficient to support normal operations. Obsolete or slow-moving inventory can create risk and potentially affect the purchase price or working capital adjustment.
What is a working capital peg in an M&A transaction?
A working capital peg is the agreed level of normalized working capital that the seller is expected to deliver at closing. If actual working capital is below the agreed target, the purchase price may be reduced. If it is above the target, the seller may receive an upward adjustment, depending on the transaction terms.
Does working capital affect the sale price of a distribution business?
Yes. Working capital can affect the final purchase price through the closing adjustment mechanism. It can also affect buyer perceptions of the amount of capital required to operate the business.
What inventory problems concern buyers?
Buyers commonly investigate obsolete inventory, slow-moving products, inaccurate inventory records, unusual inventory increases, customer-specific stock and weak inventory turnover.
How is normalized working capital determined?
The parties generally analyze historical working capital and determine what level represents the company’s normal operating requirements. A trailing twelve-month analysis is commonly used, but seasonality and unusual circumstances may require a different methodology.
Can a seller reduce inventory before selling the business?
Inventory can and should be managed efficiently, but artificially reducing inventory before closing can create problems if the business is delivered below the agreed working capital requirement. Buyers generally expect the company to be delivered in its normal operating condition.
Why is working capital especially important for distribution companies?
Distribution companies typically carry significant inventory and accounts receivable, making working capital an important part of their operating model. A buyer needs confidence that sufficient capital will remain in the business to support customers and suppliers after closing.
Final Thoughts
For a distribution business, the headline valuation is only the beginning.
The real transaction economics are determined by what the buyer believes it is actually receiving.
That includes the earnings.
The customer relationships.
The supplier relationships.
The inventory.
The receivables.
And the amount of working capital required to keep the business operating normally.
A seller who understands these factors before entering the market has a significant advantage.
Because once a buyer identifies an inventory problem or challenges the working capital peg, the seller is negotiating from a much weaker position.
The best time to understand your working capital position is before a buyer does.
Understand the Value Behind Your Balance Sheet
If you are considering selling your distribution business within the next one to three years, Horizon M&A can help you evaluate the factors that may affect valuation and transaction proceeds before you go to market.
Understand your business value, identify potential buyer concerns and prepare your company for a stronger exit.
Explore Horizon’s Distribution M&A Resources →
Or Schedule a Confidential Consultation with Horizon M&A → to discuss your valuation, working capital position and exit strategy.