Inventory: In a business sale what is it worth?

December 15, 2009

Inventory is a key portion of many business-for-sale transactions.  Brokers handle it differently.  Some include it in the value of the business and others conclude the value does not include the inventory and add it on top.  I am one of the former though have listed business with inventory on top of the value determined from a weighted value of cash to owner and assets.  However,  when this latter is the method, adding the value of inventory to the weighted value, cash to owner is adjusted for a carrying cost based on the inventory value.

However, calculation of value for a potential sale is only the first time in a sale process when inventory is important.  During due diligence, a prospective buyer can ask for a report of inventory to help determine whether a value makes sense.  At close, buyers and sellers typically ensure an inventory is done to finally justify the value based on inventory to be transferred to the buyer.

During this (hopefully) last phase of of a business being sold, counting the inventory when things can get really interesting.  There are business hoarders just as there are individuals who horde things at home.   Or, perhaps, they have just not had an opportunity to get the old things out.  At the end of the inventory the transaction value can change based on inventory being up or down from the purchase agreement price and agreement.

There are many possible points of contention.  Some of these include:

1.  Cost is not clear due to age or record keeping methods

2.  Age of inventory

3.  Current for-sale items

4.  Cost varies from one piece to another of the same item

5.  Condition of inventory

One way to avoid disagreements is to outline in advance, as part of the original purchase agreement or as an amendment if during the due diligence the inventory evaluation suggests a need, what items will be include and their value.

Example:  All items purchased within the 18 month period prior to the sale of the business; Items valued at the most actual purchase price; No items not in first-rate condition.

Doing an inventory can be a lot of work.  But, once completed and agreed to eliminates or minimizes future claims that what was sold was not actual.  The buyer and seller can hire some independent person to do the inventory using parameters agreed on.

See more on this topic at http://www.bizben.com/articles/89-inventory-small-business-sale.php

Like with so many pieces of a business-for-sale transaction, the more you agree to up front, the better.  The more deliberate the activity, the better.  Don’t cut corners.

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