In Short
-
When selling a business, clearly define in the sale agreement exactly what counts as “stock” (finished products, work-in-progress, raw materials, etc.) and specify how its value will be calculated (e.g. cost price, landed cost).
-
Agree up front on how and when a stocktake will be done, ideally just before completion, or include an estimated value with a post-sale adjustment.
-
Include a process for resolving disputes (for instance, using an independent stocktaker) and decide how to deal with unsaleable or “dead” stock.
Tips for Businesses
Make sure your sale contract leaves no ambiguity. List precisely what stock is included, how it will be valued, and when the stocktake will occur. Also, negotiate how unsellable stock will be treated and build in a clear dispute-resolution clause before closing to protect yourself and the buyer.
When selling your business, stock and inventory often form a significant component of the sale price. If you do not set out the process for dealing with stock in the business sale agreement, you may end up in a dispute with the buyer at or after completion. This article explains what a business sale agreement should include for stock sales and how to address disputes involving stock.
Defining Stock and Stock Value
Stock generally refers to finished goods that are ready for sale to your customers. If you operate a retail, wholesale or distribution business, your stock is probably the core part of your business.
If you use any goods or products in the manufacturing or supply of your stock, such as raw materials, parts, packing material, etc, this is commonly referred to as:
- Inventory: A broad term encompassing stock, raw materials, and work-in-progress. In many contexts, inventory and stock are used interchangeably, especially in retail settings.
- Work-in-progress: Partially completed goods at various stages of production. It is not yet ready for sale, but it has had some value added.
Lastly, you will need to determine your stock’s value (outlined below) if the buyer is purchasing it as part of a business purchase.
Essentially, when selling your business, ensure your business sale agreement contains:
- a clear description of the stock (including work-in-progress/inventory, if relevant) that will be sold to the buyer; and
- how your stock will be valued.
When you are ready to sell your business and begin the next chapter, it is important to understand the moving parts that will impact a successful sale.
This How to Sell Your Business Guide covers all the essential topics you need to know about selling your business.
Valuation Methods
You can use various methods to determine your stock’s value. Generally, this is a matter of negotiation with the buyer. For example, you could choose to value your stock based on the:
- original price you paid for the stock, plus an appropriate portion of the delivery cost; or
- the costs set out above, plus landed costs, which include taxes, exchange rate conversions, and customs and handling fees.
‘Dead Stock’
Depending on the type of stock you sell, you may also have accumulated ‘dead stock’. Dead stock is stock you have had for a long time and have not been able to sell, or stock that will expire soon. Examples include:
- outdated technology;
- out-of-season products;
- expired perishables;
- discontinued items; and
- overstocked products due to overestimated demand.
You will need to negotiate with the buyer on how to deal with this obsolete or perishable stock. You may choose to:
- sell this stock to the buyer at a reduced value;
- include this stock in the sale, but exclude it when calculating the value of your stock; or
- exclude this stock from the sale and retain ownership of it. In this situation, you may be able to sell your dead stock to a third party.
Process for Stocktake
Once you have decided what stock is included in the sale and how you will value it, you should specify how you will undertake a stocktake in the business sale agreement. The more critical the stock is in the sale of your business, the longer the stocktake process will take.
Generally, you should conduct the stocktake as close to the completion date as possible to ensure the figures are up to date. You will need to allow enough time to conduct the stocktake if you have:
- a large amount of stock; or
- valuable stock that requires appraising.
If the actual value is less than the estimated value, you will pay back the difference to the buyer. However, the buyer must pay you the difference if the actual value exceeds the estimated value.
If you have a large amount of valuable stock, you and the buyer might agree that an independent valuer should conduct the stocktake instead. Either way, it is essential to conduct an accurate stocktake to ensure you are paid the correct amount.
Dealing With Disputes
Businesses should consider employing a stocktaker during a business sale in scenarios such as:
- retail store transfers;
- manufacturing company acquisitions;
- hospitality business handovers;
- automotive dealership sales; and
- transactions involving seasonal or multi-location enterprises.
These situations often involve complex or high-value inventory that significantly impacts the overall business valuation.
Your business sale agreement should set out a process for resolving any disputes between you and the buyer regarding the value of your stock. Usually, this dispute resolution process involves appointing an independent stocktaker to conduct a stocktake if you and the buyer cannot agree on the stock value.
However, appointing an independent stocktaker can be expensive. When considering whether you want to include this as a dispute-resolution mechanism, consider the following:
- value of the stock;
- value of the sale in total; and
- the ability for you and the buyer to pay the stocktaker.
Generally, a buyer and seller will each pay half of the stocktaker’s costs. However, this is a commercial issue that needs to be negotiated with the buyer. If your stock is a valuable part of your business, we recommend this dispute resolution process. It ensures a straightforward method for determining stock value and that you are paid correctly for your stock.
Other Issues To Consider
Two additional issues that often arise in respect of the sale of stock include:
- whether you should agree to a maximum sum for stock; and
- how the parties intend to deal with any warranty claims from existing customers.
1. Maximum Sum for Stock
It is common to encounter a buyer who requests that a provision for a ‘maximum sum for stock’ be inserted in the business sale agreement. This generally means they do not have to purchase stock above that sum, even if the stocktake shows the stock value exceeds it. If the stock value exceeds the maximum amount, the buyer can choose which stock to include or exclude from the purchase.
A maximum sum term allows the buyer to better prepare for the costs payable to you at completion, as they will only have to pay you up to that amount. Whether you include this term in your business sale agreement is a matter for commercial negotiation between you and the buyer.
2. Warranty Claims
When you sell your business to a buyer, be aware that you may still be responsible for certain consumer guarantees. Under Australian Consumer Law, your customers have certain rights regarding the products you sell to them. For example, all products you sell must be of acceptable quality.
If your product does not meet these consumer warranties, a customer may be entitled to a refund, repair, or replacement. Your business might also have offered additional warranties to customers, such as agreeing to replace a laptop if it malfunctions within 12 months of purchase.
You will remain responsible for these warranties after completion unless the buyer expressly assumes them under the business sale agreement. If the buyer chooses not to accept these potential liabilities, you may need to maintain your business insurance after completion to cover you in case any claims arise.
Key Takeaways
If the sale of your business includes the sale of stock to a buyer, clearly define what stock you agree to sell and its valuation process in the business sale agreement. Your agreement should also set out the process for undertaking a stocktake, including dispute resolution mechanisms. Nevertheless, addressing these issues in an asset sale can be complex.
If you would like assistance with your business sale, our experienced mergers and acquisitions lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Theoretically, if you are conducting a stock sale, you can choose a different valuation method for different individual assets or items. However, you will need to negotiate this commercially with the buyer.
Generally, only items you hold for sale to customers count as your stock, such as finished products. Any materials or goods you use to produce or manufacture your finished goods are not usually considered ‘stock’ and instead are referred to as ‘work-in-progress’ or ‘inventory’, unless otherwise agreed in the business sale agreement. For example, holding spare parts for repairs or maintenance does not constitute stock. However, if you sell spare parts to customers, they are in stock.
We appreciate your feedback – your submission has been successfully received.
