Buying a distribution business: what to check in the numbers
Short answer
A distributor's value rests on its supplier lines and customer relationships. When buying one, read every supplier agreement for territory, exclusivity, termination and change-of-control clauses, check inventory turns and dead stock, review gross margin by line and customer, and look closely at receivables and working capital, since distributors tie up a lot of cash in inventory and customer credit. Then check warehouse, fleet and the sales team's relationships.
Distributors earn a margin for moving goods between suppliers and customers. If a key supplier leaves, the business can lose a product line overnight.
Supplier and customer checks
- Every supplier agreement: territory, exclusivity, minimums, termination notice, change of control.
- Revenue and gross margin by supplier line and by customer.
- Rebates and volume incentives: how they're earned and booked.
- Price increase pass-through to customers.
- Sales rep relationships, compensation and agreements.
Worked example: how much cash the business ties up
Distributors buy before they sell and sell before they collect. The gap between paying suppliers and collecting from customers is cash the business has to carry, and it grows with sales. Work it out before you agree a working capital target.
Illustrative example, not a real distributor
Annual sales are $6.0 million and cost of goods sold is $4.5 million (a 25% gross margin). Average inventory is $900,000, so turns are $4.5 million ÷ $900,000 = 5, or about 73 days on hand (365 ÷ 5). Customers pay in about 45 days, so receivables average $6.0 million × 45 ÷ 365 = about $740,000. Suppliers are paid in about 30 days: $4.5 million × 30 ÷ 365 = about $370,000 of payables. Net working capital is $900,000 + $740,000 − $370,000 = $1,270,000. If you grow sales 20% on the same terms, that figure grows by about 20% too, roughly $254,000 of extra cash you'd need to find. Now ask what happens if a key supplier tightens terms to 15 days for a new owner: payables fall by about half, and you need about $185,000 more on day one.
Inventory, receivables and operations
| Item | What to check |
|---|---|
| Inventory turns by line | Slow and dead stock; returnability to suppliers |
| Physical count vs book | Shrink and valuation |
| Receivables aging | Collectability, bad debt history |
| Payables terms | Supplier credit available to a new owner |
| Warehouse lease and fleet | Term, cost, condition |
Set the working capital target carefully; see working capital peg.
Liens, credit lines and supplier credit
Most distributors borrow against inventory and receivables on a revolving line of credit, and the lender files a UCC lien over those assets. That lien has to be paid off and released at closing, and you'll likely need your own line from day one. Run a UCC search early (see UCC lien search). Suppliers also extend credit based on the owner's history; ask the major ones, with the seller's permission, what terms they'll give a new owner. A supplier that moves you to cash in advance can change the working capital math overnight.
Warehouse and operations
Walk the warehouse. Look at how stock is located and counted, how much is dusty, and whether the bin locations in the system match the shelves. Ask for the last physical count and its variance to the books. Forklift operators need training and evaluation under OSHA's powered industrial truck standard (29 CFR 1910.178); ask for training records and the injury log. Check the warehouse lease term, the fleet's age, and delivery routes and costs if the distributor delivers.
What an SBA lender will check
A lender will match tax returns with IRS transcripts, count inventory and age receivables, and look hard at supplier concentration and the change-of-control clauses in line agreements. They'll want the working capital needed after closing built into the deal, often as part of the loan or a separate line, because a distributor that runs out of cash can't buy stock. See working capital peg and receivables in a sale.
Worked example: what one supplier line is worth
Illustrative example, not a real distributor
Line A is $2.4 million of the distributor's $6.0 million of sales (40%) at a 22% gross margin, so $528,000 of gross profit, plus $60,000 of annual volume rebates. Total contribution from Line A: $588,000 of the company's $1,560,000 gross profit including rebates, about 38%. The supplier agreement allows either party to end it on 90 days' notice and requires consent for a change of control. If the supplier moved the line to a competitor after the sale, the business would lose $588,000 of gross profit while warehouse, delivery and sales costs mostly stayed. With EBITDA of $450,000, that's the business. Talking to that supplier before closing isn't optional, and the consent should be a closing condition.
What moves the value of a distributor
We don't value deals or publish multiples we can't verify. Appraisers and lenders weigh these factors:
| Factor | Supports a higher value | Pulls it lower |
|---|---|---|
| Supplier lines | Exclusive or long agreements, several key lines | One line, cancellable on short notice |
| Customers | Many accounts, repeat ordering | A few large accounts |
| Inventory | High turns, little dead stock | Slow and obsolete stock |
| Margin | Stable gross margin, rebates documented | Margin propped up by rebates that may change |
| Working capital | Short cash cycle, good supplier terms | Long cycle, cash-on-delivery suppliers |
| People | Sales reps with tenure and agreements | Owner holds all key relationships |
Red flags specific to distribution
- A supplier that has started selling direct to your customers, or online.
- Inventory growing faster than sales for two or more years.
- Receivables aging lengthening, or large balances from a few customers.
- Rebates booked as income in the year received rather than when earned, distorting year-to-year margin.
- Sales reps on informal commission arrangements with no non-solicit.
- A warehouse lease ending soon with no suitable alternative nearby.
The first 90 days after you buy
Visit the top suppliers and customers with the seller in the first weeks. Confirm supplier credit terms in writing for the new entity, and have your own line of credit in place before the first large purchase order. Do your own physical count within the first month to set a clean baseline, and review the slowest-moving stock with the sales team. Hold off on changing product lines or pricing until you've seen a full ordering cycle for the major customers.
Documents to request
- Every supplier agreement, with territory, exclusivity, termination and change-of-control terms.
- Sales and gross margin by supplier line and customer, monthly, for three years.
- Rebate program terms and statements.
- Inventory by SKU with cost, age and turns; last physical count and variance.
- Receivables and payables aging; credit line agreement and UCC filings.
- Warehouse lease, fleet list, delivery routes and costs.
- Sales rep roster, compensation plans and agreements.
- Tax returns, financial statements and bank statements.
Questions to ask the seller
- Which supplier lines make up most of your gross profit, and can any end on short notice or on a sale?
- Have you spoken to key suppliers about the sale, and what did they say?
- What rebates did you earn each year, and how are they booked?
- How much inventory hasn't moved in twelve months, and can it be returned?
- Which customers pay late, and what's been written off?
- Which sales reps own the biggest customer relationships, and are they staying?
Frequently asked questions
Can a supplier end a distribution agreement after a sale?
Often yes. Many supplier agreements allow termination on short notice or require consent on change of control. Talk to key suppliers, with the seller's permission, before closing.
Why does working capital matter so much?
Distributors carry inventory and extend credit to customers. Buying the business without enough inventory and receivables, or the cash to fund them, can starve it quickly. See working capital peg.
What are inventory turns?
Cost of goods sold divided by average inventory. Low turns or rising inventory without rising sales can mean slow or obsolete stock.
Who owns the customer relationships?
Often the sales reps or the owner. Check whether reps have non-solicitation agreements and how long they've been there.
How do supplier rebates affect a distributor's earnings?
Many distributors earn volume rebates or incentives from suppliers, often paid quarterly or annually and sometimes booked when received rather than when earned. Ask for each rebate program's terms and the payments for three years. A rebate earned on volume a new owner can't sustain, or one a supplier can change at will, shouldn't be counted as steady earnings.
How do I verify a distributor's revenue and margin?
Tie sales invoices by customer to the bank and tax returns, then compare purchases from each supplier with sales of that supplier's lines. Gross margin by line should be consistent with supplier price lists and customer pricing. Rebate statements from suppliers confirm the rebate income the P&L shows.
Sources
- SBA SOP 50 10 8.1, Appendix 15 (working capital and QoE)
- UCC Article 9 (secured transactions: inventory and receivables liens)
- OSHA: Powered industrial trucks (forklifts), 29 CFR 1910.178
Related guides
General information, not legal, tax, financial or investment advice. Rules and lender practices change; check the linked sources and talk to your attorney, CPA and lender about your deal. Examples with named numbers are illustrations, not real businesses. OKtoBuy's Deal Check does not value businesses or give price opinions.