By Dave Driscoll
Small business owners seem to have an aversion to inventory: they don’t like to count it, deal with it, and frequently don’t realize how much value they have invested in it.
As business brokers, we encounter this phenomenon too often. Owners routinely minimize the importance of inventory value when listing the businesses for sale. Consistently, owners claim they really don’t have that much inventory, have never physically counted it, and fear that suddenly taking inventory would prompt difficult questions from their employees.
If you buy products for resale or materials that are used anywhere in the process to create your product, then you have inventory. You are investing company dollars to create value that, in turn, you sell to your customers.
Small business entrepreneurs are so focused on producing and selling that I suspect keeping track, counting, and valuing inventory are seen as small details that just aren’t worth their time.
However, when considering selling the business, the owner’s main focus is “how much can I get for my business?” We generate a business valuation that defines the cash flow created by the business that is at the discretion of the owner; that is, what the business makes that the owner can spend!
When finalizing the asking price and terms of the sale, the question always comes up: does the asking price include inventory, or is the inventory value at the date of sale in addition to the asking price?
Sellers who do not know the value of the business’ inventory either choose to list the business including inventory or stating that the value of inventory to be paid for at closing is no greater than $x. Owners in these situations are setting themselves up for a big surprise in the final hours leading up to closing the sale of the business. A surprise that just may kill the deal.
Let me be clear: at the eleventh hour, the buyer, their lender, and the IRS WILL need to know the true value of the inventory in the business on the date of sale. Just when everyone believes the transaction is about to close, this seemingly minor factor can jeopardize the sale.
In one instance, a seller insisted on including inventory in the selling price for two reasons. First, they were convinced that all items purchased moved out through sales and whatever remained was insignificant. Second, they had never taken inventory and did not want to risk tipping off the employees regarding the sale.
Well… the seller actually had $150,000 of inventory on the floor! OMG!!!
Negotiations led to the buyer paying only a third of the price of the inventory – meaning the seller sacrificed a significant amount of money because of the initial resistance to doing inventory.
Another seller was emphatic there was NO WAY the inventory exceeded $10,000 in value. The Asset Purchase Agreement stated that any deficit from the $10,000 would be credited to the buyer, and any excess would be credited to the seller.
Then, in order to finance the deal, the buyer’s bank required the seller to physically count and value the inventory. The IRS also needed the inventory value to allocate the sale price for taxes. Surprise – the inventory value totaled $32,000! Suddenly, the buyer was expected to pay $22,000 more than anticipated…but, the buyer simply didn’t have that money! This was a deal breaker the day before closing!
Thankfully, the buyer and seller reached a compromise on a reduced value for the excess inventory. Disaster averted, but the seller ultimately lost value.
When listing your business for sale, follow this broker’s advice and count and value your inventory. Better yet, make inventory a routine part of your business process – you’ll gain valuable insight. Then discuss with your broker whether to include inventory in your asking price or to provide a realistic estimate of inventory value to be paid at closing on top of the sale price.
Dave Driscoll is president of Metro Business Advisors, a business brokerage, valuation and exit planning firm helping owners of companies with revenue up to $20 million sell their most valuable asset. Reach Dave at DDriscoll@MetroBusinessAdvisors.com or (314) 303-5600. www.MetroBusinessAdvisors.com