Handling Inventory When Selling a Business

But what does the owner have to sell? How will the structuring of the sale impact her net, particularly is it pertains to taxes? And how should the opportunity be marketed with regard to price?

The owner – who, I hasten to add, I don’t know – has a reputation for pinching pennies. But the expression “penny wise but pound foolish” is appropriate in this case because even though she had a $2 million (revenue) business, she consulted no one – such as a tax attorney, an accountant or a business broker – who might reasonably have been able to help her structure the transaction to her best advantage. Instead, she consulted a residential real estate agent and someone at the company that handles that agent’s closings, neither of whom had the slightest experience with selling businesses.

What Was On Offer?

In this case, there were several “items of value” that comprised the sale.

1. The real estate, which is presumably why the owner called a real estate agent.
2. The business’ tangible and intangible assets, which included its name, phone number, website and sundry similar assets
3. The inventory
4. The “goodwill”

Only two of these fours items was purported to have been valued: the real estate and the inventory. Unfortunately, both were valued by the owner!

The real estate agent – a residential agent, at that – didn’t know how to value a commercial property and, thus, agreed to list everything except the inventory at the price the owner wanted.

The agent also took the owner’s word that the inventory was valued at $100,000. The listing – a real estate listing on a real estate multiple listing service – stated that the real estate was for sale for $750,000 and that the inventory could be bought for $100,000.

What’s Worth What?

We were not involved in this transaction (thank goodness!). As such I have no idea what the real estate was worth. But the allocation of assets, a crucial step in the structuring of the transaction to keep the seller’s current tax liability manageable and the buyer’s future tax position knowable, was completed ignored.

On top of that, unless the four components of the sale are broken out, the seller’s closing costs and the buyer’s future property tax liabilities could be higher than necessary.

But the big issue in this transaction was how the inventory was treated – which is to say, poorly.

What’s The Inventory Worth?

Inventory changes day-to-day in nearly every business. In many retail businesses, inventory spikes during the month before Christmas – but then plummets a month later. To say that the inventory “…can be bought for $100,000…” ignores completely the likelihood that the value of the inventory on any given day – let alone on the day of closing – will, in fact, be nowhere near $100,000.

So, how do we handle inventory?

We ask the seller to estimate the average value of the inventory on a day-to-day basis recognizing that it could fluctuate wildly. We explain the we’ll market the business at X price and that that price “includes inventory valued at (whatever the seller estimated)”.

You might think at this point that a seller could assume that she could pad the inventory a little bit – give it an extra $150,000 in value, say. (Yes, there are dishonest sellers out there as this post and this one will clearly  demonstrate.) But we explain that an inventory will be taken the day before closing and the price will be adjusted – up or down – based on the value of the actual inventory at the time of the sale.

For example, we are working with a wholesaler/distributor that buys seasonal product in bulk, breaks that product down, repackages retail amounts of the product and distributes the repackaged products to hundreds of retail outlets in the U.S. and Canada. In season, the inventory level is about $450,000. Off season, it’s less than $100,000. We’re marketing the business at X price and “that price includes $250,000” in inventory.

The Bottom Line

Having an inventory done by a disinterested third party eliminates much of the potential for the parties disagreeing on the value of the inventory. It will also help both parties when it comes time to report the transaction to the taxing authorities.

There are firms out there that do nothing but take inventory for businesses, large and small. We use them whenever inventory is involved in a transaction. Because having an accurate inventory at the closing is in the best interests of both buyer and seller, we are usually able to convince both that they should share the relatively small cost.