Handling Inventory In Connection With Selling A Small Business

It might be the most tedious thing you do when buying or selling a small California business for sale, but conducting inventory--counting out the items that are sold (in a retail store or distributorship), or used in running the business (such as food stuff in a restaurant or parts in a manufacturing company)--is absolutely essential during due-diligence.

The contract may call for inventory to be paid separately at, or following close of escrow. Or the arrangement might be to include inventory as part of the purchase price of the small business for sale. In either event, this part of the transaction can’t be completed until the actual count has taken place.

And that calls for the admittedly boring, hands-on process of viewing every item in stock or in supplies, checking on its cost--using catalogues and supplier price sheets--then adding the information to the inventory count.

Some sellers may recommend using their computer-based inventory systems to determine the count of items and their costs, but from the buyer’s point of view, it’s worth the extra time and effort to perform a physical count. That’s because some of the merchandise listed in stock, according to the inventory system, may actually be missing. It isn’t fair for a buyer to purchase “phantom” inventory. Besides, a physical check may show that some of the items have been on the shelves for a while, and the actual cost to acquire them would accurately be reflected on older price sheets, rather than the higher costs reflected in the current price database on the computer.

The Easter baskets gathering dust in a corner of the stock room at the back of the gift shop, for example, may have been purchased several years ago, at prices that are lower than those listed for baskets that the store would acquire today. And the inventory software used at the business, unless it’s pretty sophisticated, may store only current pricing. If the buyer is to pay for inventory at cost, an effort should be made to establish the exact price paid for each item by the seller, not what that items sells for today.

Timing of this count is usually somewhat flexible. If the buy/sell agreement calls for inventory to be purchased in addition to the price, the escrow can be closed before the final inventory value is determined. It only is when the contract calls for the price to include inventory, that the escrow cannot be completed until the count and pricing procedures are finished and the total dollar value of inventory is supplied to the escrow holder.

GOOD JOB FOR BUYER/SELLER

It’s ideal if the count is performed by the buyer and seller together. It gives them an opportunity to begin some of the training that usually is called for in a business purchase agreement. As they go over the items in stock, the seller can answer questions about where certain products are sourced (identifying the vendor), and what is the best way for specific items to be sold (in a retail setting) or used (if it’s a service business).

And when questions arise, as they invariably do, regarding how to value a particular item, who better to agree on a fair valuation than the principles to the business transaction? How to price those old Easter baskets--borrowing from the example noted above--in the absence of the original cost sheet, is a question that can be resolved with a bit of negotiating and compromise. And it should be up to the buyer and seller--the people who will be paying and receiving the cash for this inventory--to decide what value to place on it.

Even when the principals to a business sale have difficulty agreeing on matters related to their transaction, they should be involved when it comes time to count and to price the inventory. This procedure usually goes pretty quickly and is rather easy when the business is a food service. But in the case of a restaurant sale that I brokered some years ago, the inventory was actually quite a difficult chore. Because the buyer and seller had taken a dislike to one another, every part of the process became contentious, when we got close to the completion of escrow. During inventory, the buyer insisted on counting the toothpicks, claiming that he was not going to be “tricked by the seller” into purchasing more inventory than actually existed. And the seller, fearing that the buyer might receive something not paid for, demanded that we weigh the salt and sugar to determine an exact cost for these supplies. In this case, I wound up doing the counting and determining the values based on the seller’s cost sheets from the food suppliers. I was able to complete the inventory in only a couple of hours, but it was a tense situation as I worked under the very watchful eyes of both parties to the transaction. And I repeatedly stopped what I was doing to ask them not to bicker over inconsequential issues.

INVENTORY SERVICES AVAILABLE

Not every business broker is as accommodating as I was, of course. And for those situations in which the parties to the deal are unwilling or unable to manage the inventory count themselves, it’s rather simple to hire an inventory service when selling a business. These companies will send out an individual or a team--depending on the size of the job--to count out the items to be tallied, look up their costs on the pricing sources provided by the seller, and generate the dollar totals needed by the parties to the deal or the escrow. Cost for this service is usually based on an hourly rate; from $150 to $300 is the range for most companies. A business broker or escrow holder usually can recommend a reliable inventory service. And failing that, these companies can be found in printed or Internet-based local business directories.

Whether the principles in the transaction conduct the inventory, or hire an outside service to manage the task, it is important to remember that “inventory” applies not only to products held for resale, but also for parts and supplies used in manufacturing and service businesses and to other kinds of supplies. The olive oil used in a restaurant, powdered cleanser needed to keep floors clean and ink cartridges used in the printer are samples of the kinds of supplies that should be included, for the parties to have a “fair” count.

If done correctly then, the inventory can be an opportunity for the buyer to get some education about the business, and can serve to complete transfer of the company with an accurate and fairly priced count of the products and materials needed to operate it.

About The Author - Peter Siegel, MBA is the founder and President of BizBen.com and the BizBen Network. A nationally recognized author (3 books and a syndicated small business blog) and expert consultant. If you are selling a business and need professional assistance utilizing high performance advertising, marketing, and highly effective strategies, or individual customization with your BizBen Power Search options in buying a California business, you can reach him at 866-270-6278.

Posted on August 15, 2011  |   Email This Blog Post   |   Print This Blog Post   |  All Contributions From Peter Siegel, MBA