When a buyer is assessing a business for sale, there are dozens of tiny details they will examine. One item that always causes a lot of negotiation is how much inventory is included in the purchase price. Because, as a seller, you want a high amount of inventory included in the purchase price. Whereas a buyer wants a low amount included. In this article we will breakdown a few tricks on how to overcome this barrier to negotiations.
Having a high amount of inventory in our businesses is not always due to irresponsible inventory management. For a shoe-store, for example, may try to carry “the widest selection of size and styles!” This creates a challenge to selling your business because the seller wants compensation for what they have bought, which raises the asking price. Whereas a buyer doesn't want to foot the bill for inventory that the seller purchased (as they may feel they don't need that much). In some cases, the inventory value can exceed the asking price of the business, which creates several challenges.
Why is inventory included in the sales price?
Well, without any inventory, there isn't much of a business to operate. Put it this way, would you buy a car dealership company without the cars? Or a bicycle shop without all the bikes? They are the business, and therefore come as part of the sale.
You may be wondering, “why can't a buyer take-out a bank loan for the inventory?” Due to the fact that banks do not want to finance inventory, because they can't put a lien on it, it creates a barrier for the transaction. Banks are more likely to finance equipment because it cannot be sold without the bank knowing about it. Whereas inventory has to be sold for the business to run, so there is less of a tab on the inventory in the banks eyes. Meaning ultimately, unless the buyer has deep pockets to pay for all the inventory, there is not a lot to be done.
So now that we have covered why inventory is important and included in the purchase price, you might be asking, “how do I sell my business if I carry a high amount of inventory?” Our answer is, be creative!
Structuring a deal with high inventory
We will describe here 3 methods that you can use to overcome this challenge. The first method is using seller consignment. This means the seller consigns the inventory to the buyer, meaning as inventory is sold off the floor, the buyer pays the seller. This reduces the amount of capital a buyer needs to purchase the business, while ensuring the seller still gets paid for the inventory they bought. While this method works for both parties, the buyer needs enough capital in the beginning for this to be profitable. This is because there is not enough profit from consignment alone to support the on-going cash flow requirements of the business.
The second method is a long term seller loan based on inventory amount at closing. With this method, the seller loans the buyer the value of the inventory. Instead of paying as you go, the loan is paid out over 10 years. This negates the need for working capital, however, sellers do not like this method very much.
Finally, the third method is to sell down your inventory at a low profit rate. As seen in big department stores such as Target and Sears, when they decide they are closing their doors for good, they put everything on massive discount in order to gain as much profit as possible. This would be the same case if you were planning on selling a smaller business. As the current owner, you could sell down the inventory at a lower cost, which would not be added to the sale of the business.
Wrapping up
When selling an inventory heavy business, the best solution is to have the seller participate in the transaction. That said, an even better method is to work on converting your business model to carry a lower amount of inventory prior to selling your business. This is not always possible depending on the nature of your business, but will make it far easier to sell your business.
Watch this video to learn more about increasing the cash efficiency of your business.
