The vast majority of LBM companies are sold on a debt-free/cash-free basis. In a debt-free/cash-free sale, you, the seller, must resolve any long-term debt out of the proceeds of the deal at the closing. The good news is that you get to keep “cash” and “cash equivalents” on your balance sheet. Upon hearing this, many of you are reaching for your phone, and dialing your accountant to ask: “How much cash do I have on my balance sheet?”
Your balance sheet may have tons of cash beyond your liabilities; many companies do. But your accountant might come back with a disappointing answer, like this: “Well, we had lots of cash three months ago. Then, you made that large OSB buy at the co-op show. And plus, you jumped on the mill’s multi-truck discount for dimensional lumber.”
You hang up, wondering why you didn’t take your Mom’s advice to become a dentist. Then you dial your accountant again: “Forgot to ask. How much cash would we have on the balance sheet in six months? That’s when the deal would close if we were acquired.”
The accountant: “Oh, that’s a much better cash position, because you will have sold off that inventory you bulked up on, and if you stick closely to your 12-month inventory average, well, you’ll have a healthy cash balance.”
You hang up the phone, triumphant: “Ah ha! Who needs dental school, when you can run a lumberyard?!”
The accountant has a point. If you see a deal on materials—and at the time you’re not really thinking of selling your company—you may be wise to draw down cash to make a purchase. That’s a classic buying behavior: Bulk up, sell down over a long period of time. But that is unwise in the year going into the sale of your company.
Any LBM dealer’s inventory management can be measured in four ways, all related to a Days on Hand (“DOH”) and inventory turns. Those four metrics are:
- DOH-Yearly Average
- Inventory Turns-Month
- Inventory Turns-On Yearly Average
If your company has a high Days on Hand, which will invariably lead to “low” inventory turns (e.g., below three time/year), you will invariably have cash unnecessarily locked up in inventory that is simply not moving that fast.
This will probably not be an issue if you are not selling your company. You place big orders a couple times a year at the co-op shows, and then sell down the items over a period of months.
Unfortunately, if you have low turns consistently over a period of years, you establish a pattern that a potential acquirer will point to and say, “Your profitability and success seem clearly based on turning inventory 3X/year. Let’s maintain that going into the closing.”
But if you want to extract as much cash out of the business at the time of sale, that 3X/year turns pattern will work against you, because you’ve got so much cash locked up in relatively slow-moving inventory. If you had been buying inventory at a higher frequency/lower volume, you’d have more cash on your balance sheet, subject to harvest at closing.
There are a couple of problems with making a last-minute adjustment to notch up your turns. You can’t suddenly “see the light” and convert to higher inventory turns just a month or two before a sale, just to bump up cash reserves. The buyer will perceive that as “out-of-pattern” and suspect (correctly) that you’re selling off inventory beyond your normal multi-month averages just to bulk up balance sheet cash at closing. The other problem is your working capital PEG which is typically based on twelve-month averages of your current assets and current liabilities. Lowering inventories several months before the close and the working capital PEG “true-up” could leave you with a negative adjustment to your working capital PEG.
Engage in frequent ordering/lower volume/ high turns/less cash locked up for months, or a full year before selling your company, while asking your investment banker to explain the changed behavior to the seller.
Clearly, maximizing cash harvest, at-close, is possible, but seek your investment banker’s help in advance to adjust your practice so it is acceptable to the acquirer.
John Wagner is a managing director at 1stWest Mergers & Acquisitions, which offers a specialty practice in the LBM sector. Reach John at email@example.com