Many businesses operate with stock in trade, but how do you know if you’ll get the benefit of the stock when you buy the business? Due diligence on the stock is essential to helping you understand what you are buying.
What is Stock in trade
‘Stock in trade’ is the goods that are owned or agreed to be bought by the seller which are then sold to customers (whether wholesale or retail) as part of running the business. It might also be referred to as trading stock or inventory, although any reference to inventory might also include the materials and equipment needed to make the stock. If you had a candle business, the stock would include candles that have not yet sold and the inventory might include components, like wicks and wax, that make up the candles.
Due Diligence on the Stock
Undertaking due diligence on the stock means thoroughly investigating what the seller has said about the stock. It involves identifying the stock that is being sold as part of the business and verifying that the seller owns and is able to sell it. Due diligence on the stock involves:
- Identify it: Identifying the stock – how much stock is there and exactly what is it.
- Where is it? It’s also essential to identify the location of the stock. The stock might be located in a different warehouse or might be in transit to the business or to a customer.
- Who owns it? Determine which stock is owned by the business. The stock might have been ordered but not yet paid for. Also determine whether there’s any stock on consignment. ‘Stock on consignment’ refers to goods that are not owned by the business, but instead owned by someone else. The ownership of the goods does not actually pass to the business. The business might only receive a payment of a certain percentage of the sale price or a commission once the goods are sold. The agreements that are in place for the consignment arrangement will also need to be reviewed.
- Want it? The goods should be sellable trading stock. If the business has been running for some time, it might have some slow-moving, old or outdated or damaged stock or returned goods that the seller might want to include in the sale. Consider which stock is part of the sale, and whether that stock is currently used in the business. With stock that’s aged, damaged, slow-moving or obsolete, decide whether you will take that stock or exclude it from the sale. Also consider whether the price of those goods, because of their condition, should be reduced.
- Count it: The stock should be verified by undertaking a stocktake. The parties should agree on the specifics of the stocktake, such as when it will occur, who will undertake the process and how it should be done.
Stock levels will fluctuate throughout the sale process, as customers continue to buy during this time. If stock levels are low, the seller might need to order new stock. Because of this, the timing of the stocktake is important, and you may need to undertake two stocktakes; one at the beginning of the process to identify the stock and one as close as possible to completion.
- Value it: The stocktake will confirm the value of the stock although the levels will continue to move right up until settlement. The purchase price might be valued separate to the value of the stock or a price might be attributed to the stock, on a ‘stock inclusive’ basis. If the stock is included in the purchase price ensure that you’ve obtained an agreed value of the stock and it is not removed from the business before completion.
- Disputes and obligations: Ensure there are no current disputes between the seller and any supplier or manufacturer of the goods, and that no debts are owing. Examine how the business deals with returns to the manufacturer (if applicable) and whether the business has a policy on customer returns.
- Agree on terms: Once you’ve agreed on the value and the terms of the stocktake, what stock you’ll take, and the extent that any other agreements will impact on your ability to obtain, own, sell and distribute the stock, you need to ensure that the agreed terms are written into the sale contract. Additionally, include a dispute mechanism for if the parties can’t agree on the value of the stock at completion.
Key takeaways: Due Diligence on the Stock
- Due diligence is an essential component of buying a business and includes undertaking due diligence on the stock.
- Due diligence on the stock includes:
- Understanding what stock the business has, including where the stock resides.
- Who owns the stock. Is the stock owned and fully paid by the business or is the stock on consignment.
- Is all of the stock saleable or is there damaged or outdated stock.
- What are the quantities and the value of the stock.
- Are there any disputes relating to the stock.
About the Author:
The following extract has been taken, in part, from the book, ‘Entrepreneur Know How – Mindset and Winning Steps for Buying a Business,’ written by Sharon Robson (Available through Amazon and select bookshops – see: https://entknowhow.com/the-bookstore
Sharon is the principal lawyer and founder of Antler Legal – a corporate commercial legal practice in Sydney, Australia.