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When you are selling your business, the sale of stock often forms a significant component of the sale. 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 will explain what the business sale agreement should include regarding the sale of stock and how to deal with disputes regarding stock.
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.
Defining Stock and Stock Value
Stock refers to the goods and finished products your business acquires or manufactures to sell to your customers. If you operate a retail, wholesale or distribution business, your stock is probably the core part of your business.
It is important to make it clear in your business sale agreement what constitutes your ‘stock’. If you use any goods or products in the manufacture or supply of your stock, such as raw materials, parts, packing material etc, you may also wish to include these as ‘stock’ for the purposes of the agreement. It is also common to include these items as ‘work-in-progress’ or ‘inventory’. You should also determine your stock’s value (outlined below) if the buyer is purchasing them as part of their purchase of your business.
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.
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
- costs set out above plus landed costs, including taxes, exchange rate conversions, and customs and handling fees.
You should choose a valuation method that reflects standard practices in your industry.
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‘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. 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 sale agreement. The greater the importance of stock 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. This will give you enough time to calculate the stock value. However, you will need to allow more time if you have:
- a large amount of stock; or
- valuable stock that requires appraising.
It is common for a stocktake to occur within a few days before the completion date so that the stock value can be finalised in time for completion. The buyer will then pay you the agreed stock value at completion. However, depending on the nature of your business, it may be preferable to include an estimated value of the stock in the sale agreement, which the buyer will pay you on the completion date. Within a specified period after the completion date, you will then conduct the stocktake to determine the stock’s actual value as at completion. 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 for an independent valuer to 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
If the sale of your stock is an essential part of selling your business, your business sale agreement should set out a process to deal with 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 of 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 to negotiate with the buyer. Ultimately, if your stock is a valuable part of your business, including this dispute resolution process is recommended. It ensures there is a clear method of determining the stock value and ensuring you get 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 where the stocktake reveals that the stock value is above that sum. If the stock value is more than that maximum amount, it can also allow the buyer to decide which stock to include or exclude in their 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 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 could claim 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 still be responsible for these warranties after completion unless the buyer expressly takes them on 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. Ultimately, whether or not the buyer assumes these warranties is a matter for negotiation and may impact the price they are willing to pay for your business.
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, dealing with these issues in an asset sale can be complicated.
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 the items you hold to sell to customers make up 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’. For example, holding spare parts for repairs or maintenance does not constitute stock. However, if you sell the spare parts to customers, these spare parts are stock. It is important that both your stock and any work-in-progress/inventory that you use in the operation of your business are captured in your business sale agreement.
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