Buying or Selling a Business: Options for Handling the Inventory

If you are buying or selling a business here in San Diego or elsewhere in California, often one of the more challenging aspects of the transaction is how to deal with the inventory. This is particularly true when the business is ongoing and is expected to continue after the sale. Inventory can be a large percentage of the assets of certain types of businesses, for example, an automobile dealership or a vending machine company. Inventory can be important in every sale/purchase, however, even for a medical or professional corporation. There are several options for handling inventory as part of your sale/purchase:

• Set a general value for the sale/purchase contract
• Conduct a general count as part of pre-closing due diligence, set a value and provide for certain minimum inventories at the time of closing
• Conduct a precise count prior to closing and adjust the price accordingly at the closing or just before the closing
• Establish a closing escrow, conduct a precise count after closing, and adjust from the escrow

As always, which option is better for your deal depends heavily on the particulars and a good San Diego corporate attorney can help draft the best language for your sale/purchase contract. As any business knows, “doing inventory” is time and labor intensive. With certain types and categories of inventory, the cost of getting an “exact and precise” count outweigh the benefit of having that precise and exact count. When inventory is easy to count and is a significant component of the value of the business, then doing a precise count pre-close is probably the better option. Moreover, within the same transaction, different types of inventory can be and likely will be treated differently.

Take the sale of a vending machine business: If there is warehouse inventory in boxes, cases, and/or pallets, maybe that inventory is easy enough to count. However, it may not be worth the trouble to have a precise count of each candy bar, bag of chips, and drink in every machine as of 9:30 am on the day of closing. This is particularly true when sales are ongoing; the count might change at 9:32 am. In this example, certainly a precise count of the machines is needed and probably a precise count of what is at the warehouse. However, the parties will probably skip a precise inventory of the specific machines at the vending locations. In terms of contract language, the parties might agree to something like: “For machines in operation at the time of the closing, said machine shall have their ordinary and customary in-machine inventory.”

Likewise, with the example of a car dealership: Since vehicles are relatively easy to count and a high component of the value of the dealership, a precise pre-closing count is best. However, a different option might be used for the maintenance and repair component of the dealership where, maybe, a general count is made for engine repair parts.

However, if the parties want a precise, exact inventory, then certainly the sale/purchase contract can require that. Since inventories can take time, the price can be adjusted pre-closing or after the closing with a closing escrow. With an escrow, certain funds are held back from the sales price and, from that amount, the price is adjusted to reflect more or less inventory.

With non-retail businesses, inventory tends to be less important and can be a smaller component of the value of the business. Thus, sometimes a general value is set in the contract or during due diligence, but none of the parties are overly concerned about an exact count. For example, with the sale of a medical practice, there might be a category of “miscellaneous office furniture” being sold, but no precise count is needed or desired. In these transactions, a general value is typically set but very little effort is made to provide a precise count.

Contact San Diego Corporate Law

For more information, contact attorney Michael Leonard, Esq., of San Diego Corporate Law. Mr. Leonard was recently named as “Best of the Bar” by the San Diego Business Journal for 2018. Mr. Leonard has received that honor for the past four years. Mr. Leonard can be reached at (858) 483-9200 or via email.

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