How Inventory Is Handled in a Business Sale

Selling a business involves many moving parts, and inventory is one of the most critical components to get right. Inventory (also known as stock) represents the goods or materials a business holds for sale or use in production. How this inventory is handled in a sale can significantly impact the deal’s value, the buyer’s satisfaction, and the smooth transition of operations.
In this comprehensive guide, we’ll explore how inventory is treated in business sales, focusing mainly on share (stock) sales while also touching on asset sales. We’ll delve into working capital adjustments, normalised inventory levels, due diligence practices, and tips to ensure your inventory doesn’t become a deal breaker. By the end, you’ll understand the best practices for handling inventory in a business sale – and be equipped to maximize your sale price and avoid surprises at closing.
Why Inventory Matters in a Business Sale
Inventory is often a significant portion of a company’s assets and directly tied to its ability to generate revenue. Including an appropriate amount of inventory in the sale is important for continuity – the buyer expects to take over a business that can continue operating at its current capacity without immediate infusion of new stock. If the buyer must replenish inventory or buy more stock right after acquiring the business, it effectively means the business didn’t come with “enough gas in the tank” to sustain its sales, potentially reducing the value they thought they were getting. For this reason, it’s customary in business sales to include a normal level of inventory in the purchase price that can sustain the current revenue of the business. Both parties need clarity on what that normal level is and how any difference will be handled.
Moreover, inventory is a key component of working capital, which represents the short-term assets and liabilities needed to run day-to-day operations. Inventory (along with accounts receivable and other current assets, minus current liabilities like payables) typically factors into net working capital calculations. Buyers and sellers pay special attention to working capital because it can affect the final purchase price through adjustments at closing. In short, inventory matters because it affects valuation, cash flow, and the seamless handover of business operations from seller to buyer.
Share Sale vs. Asset Sale: Inventory in Different Deal Structures
The way inventory is handled will depend in part on the deal structure – whether you’re doing a share sale or an asset sale. In a share sale, the buyer is purchasing the owner’s shares of the company. The company’s entire business – including all assets and liabilities – transfers to the new owner as a going concern. This means in a share sale, the inventory is automatically included as part of the business that changes hands. The buyer ends up owning the company with its inventory on hand (as well as its receivables, payables, equipment, etc.), unless the purchase agreement specifies certain assets to be removed.
In an asset sale, by contrast, the buyer purchases specific assets of the business (and may assume some liabilities) rather than buying the legal entity itself. Only the assets listed in the purchase agreement transfer to the buyer, so inventory must be explicitly addressed and included if the buyer is to get it. In practice, most buyers of an ongoing business will want the inventory, since it’s needed to continue operations and generate revenue immediately. However, the treatment of inventory in the agreement can differ. In many small business asset sales, it’s common for the base purchase price to exclude inventory, with inventory being handled as an additional value determined at closing. For example, a buyer and seller might agree on a price for the business “plus inventory at cost,” meaning the inventory’s value will be added (or subtracted) based on a count of actual stock on hand on the closing date.
Key differences at a glance:
- Share Sale: Inventory (and other working capital items) are included in the business by default. The buyer expects the business to come with a normal level of inventory, and this is usually accounted for through a working capital adjustment mechanism rather than a separate price for inventory.
- Asset Sale: Inventory must be specified in the deal. Often the contract will set a method to value the inventory (often at cost) and adjust the purchase price based on the actual amount of usable inventory at closing. The base price may include a normal inventory amount, with a clause to increase or decrease the price if actual inventory is above or below that level.
No matter the structure, both buyer and seller should clearly agree on how inventory is defined, valued, and verified during the sale process. Next, we’ll look more closely at the prevalent approach to handling inventory in share sales through working capital targets, then address asset sale considerations in more detail.
Handling Inventory in Share Sales
In a share sale, the entire company is sold to the buyer, so all assets and liabilities remain with the company under new ownership. Here’s how inventory is typically handled in such transactions:
Due Diligence on Inventory Quality and Value
Long before closing day, the buyer will conduct due diligence on the inventory. The buyer’s goal is to confirm the quantity, quality, and condition of the stock, and to spot any issues like obsolete or unsellable items. This involves reviewing inventory records and often a physical inspection or sample counts. During due diligence, buyers verify inventory quantities and identify obsolete or slow-moving inventory. If they find inventory that is damaged, expired, or just not selling, they may seek to write down its value or exclude it from the valuation. It’s common for buyers to request adjustments for obsolete inventory, meaning that portion of stock won’t be valued at full cost in the deal. For instance, if a seller has £100,000 of inventory on the books but £20,000 of it is old stock unlikely to ever sell, the buyer might insist that only £80,000 is counted as real inventory value – or require the seller to dispose of or discount the obsolete items.
The buyer will also examine inventory accounting methods. Are you using FIFO or LIFO accounting? How do you value inventory – at cost or market? Consistency matters. Any large discrepancy between the book value of inventory and its actual market value will be noted. If inventory has been overstated, the buyer may negotiate a purchase price reduction to compensate. Disclosures and warranties in the purchase agreement often cover inventory – the seller may need to warrant that the inventory is salable and properly valued on the books. All this diligence ensures there are no nasty surprises about inventory after the sale.
Tip for sellers: Before selling, clean up your inventory! Get rid of obsolete stock or write it off. Ensure your records match the physical reality. This will increase buyers’ confidence and avoid value-chipping negotiations over dead stock. The age of your inventory can directly affect the value of your business, so keeping inventory fresh and accurately accounted for is in your best interest.
The Working Capital Adjustment and “Normalised” Inventory Levels
One of the most important mechanisms for handling inventory in a share sale is the working capital adjustment. In nearly all medium and large business sales (and even many small ones), the purchase agreement will include a target net working capital that the seller must deliver at closing. Net working capital (NWC) typically includes inventory, accounts receivable, and other current assets minus current liabilities like accounts payable. Cash is often excluded (the seller usually keeps the cash in an equity sale), and debt is handled separately. The idea is that the business should come with enough working capital to operate normally on day one, so the buyer doesn’t have to inject extra money just to keep the wheels turning.
How do they decide the right amount of working capital (including inventory)? Typically, buyer and seller negotiate a “normalised” working capital level based on the company’s historical performance or future needs. Often they will average the monthly working capital over the past 6–12 months to find a normal level. This accounts for seasonality – for example, if the business is seasonal, the target might be set to an average that reflects normal in-season and off-season inventory levels. If the business is growing fast, the target might be adjusted upward to ensure the buyer gets enough inventory and receivables to meet current sales trends.
Inventory is a big part of this calculation. A “normalised inventory level” is inherently included in the normalised working capital. Sellers should maintain inventory at that normal level through closing. If the seller sells down inventory excessively before closing (to generate cash), that could drop working capital below the target and trigger a purchase price reduction. Conversely, if the seller piles up extra inventory (maybe buying a lot of stock pre-closing), the buyer won’t mind inheriting it but typically will pay extra for the excess via the adjustment clause. The working capital clause protects both sides: the buyer gets what they need to run the business, and the seller gets paid for any above-normal assets delivered.
The purchase agreement will specify a target working capital (sometimes called a peg). At closing, the actual working capital is measured and compared to the target. If actual working capital (incl. inventory) is higher than target, the purchase price is adjusted upward to pay the seller for the extra value; if it’s lower, the price is adjusted downward so the buyer isn’t overpaying for missing inventory or other current assets. For example, if the agreed target is £500,000 NWC and at closing the business has only £450,000, the seller might have to credit £50,000 back to the buyer. These adjustments ensure fairness since working capital can fluctuate day by day with shipments, sales, and purchases.
Normalised working capital = normalised inventory. This concept prevents gamesmanship around closing. Sellers are discouraged from doing things like delaying payables (which would inflate working capital) or liquidating inventory (which would deflate working capital) to manipulate the price. In fact, many agreements include covenants that the business must be run in the ordinary course, maintaining inventory levels, between signing and closing. It’s in both parties’ interest to keep operations normal.
It’s critical that both buyer and seller calculate working capital using the same methods both for the target and the closing calculation. For instance, if the buyer at closing applies stricter accounting (like GAAP with reserves for obsolete inventory or bad debt) that the seller didn’t apply when setting the target, it can unfairly skew the numbers. Imagine the target inventory value was set from the books without an obsolescence reserve, but at closing the buyer suddenly knocks off 10% of inventory value as “obsolete reserve” – that would lower the measured working capital and cut the price, even if nothing actually changed in the business. To avoid such disputes, the purchase agreement often specifies that the closing working capital will be calculated using the same accounting principles as the sample calculation used for the target. In practice, this means if the seller didn’t have an obsolete inventory reserve historically, the buyer can’t introduce one for closing unless they also agreed to adjust the target for it. Consistency is key to fairness.
Closing Date Inventory Count and Transfer
As the deal moves to closing, typically there will be a plan for confirming the actual inventory on hand. In many cases, a physical inventory count is conducted at or just before the closing date. This count might be done jointly by buyer and seller (or by a neutral inventory counting firm) to ensure everyone agrees on what’s there. The inventory count feeds into the final working capital true-up for a share sale, or directly determines the inventory value in an asset sale (more on that soon). By doing a joint count, the parties avoid later arguments – it provides transparency and a concrete basis for any adjustment.
Once closing occurs, the ownership of the inventory transfers to the buyer as part of the business assets. In a share sale this is seamless (the company still owns the inventory, just the shareholder changed). The buyer will then integrate that inventory into their own operations. Often, a post-closing integration plan covers how to merge inventory management systems, re-ordering processes, suppliers, and warehouses to ensure continuity. From the buyer’s perspective, aligning the acquired company’s inventory policies with their own can yield efficiencies (for example, optimizing stock levels or consolidating purchasing for volume discounts). From the seller’s perspective, having proper documentation and systems in place makes this integration smoother and gives the buyer confidence in what they’re buying.
Summary for share sales: The inventory in a share sale is handled through the working capital mechanism. The seller delivers a normal level of inventory, confirmed by diligence and a closing count, and the price is adjusted if the inventory (as part of working capital) is above or below the agreed norm. Both parties should prepare for this by studying historical working capital, agreeing on accounting practices, and communicating clearly on how inventory will be managed up to closing. When done correctly, this results in a fair price and a smooth hand-off of inventory to the new owner.
Handling Inventory in Asset Sales (and Small Business Sales)
In an asset sale, the treatment of inventory is a bit more explicit in the contract. The purchase agreement should spell out exactly how inventory is being dealt with. Here are common practices and considerations for inventory in asset transactions:
- Including “Normal” Inventory in the Price: Much like in share sales, it’s customary to assume a normal operating level of inventory is included in the deal. Professional business brokers often list a business for sale with a normal level of inventory included in the asking price. This means the buyer expects to get, say, “approximately £X of inventory” at closing as part of the agreed price. This level is usually enough to sustain the current sales of the business.
- Inventory Count and Price Adjustment: To ensure the buyer pays for the actual amount of inventory received (no more, no less), contracts usually call for a physical inventory count before closing, and an adjustment to the price based on that count. For example, if the deal price assumed £100,000 of inventory and the count finds only £90,000, the purchase price might be reduced by £10,000. If instead £110,000 is on hand, the buyer might pay the extra £10,000 to the seller. This approach is common when inventory value is significant and can fluctuate. It protects both sides – the buyer doesn’t overpay for missing stock, and the seller gets paid for all the inventory they deliver.
- Valuing the Inventory: In asset sales, inventory is typically valued at the seller’s cost (not retail price). Using cost makes sense because that’s likely what the seller has invested into the stock, and it avoids the seller getting a windfall profit on inventory or the buyer paying markup on goods they still have to sell. In fact, from a tax standpoint, inventory in an asset sale is often transferred at cost which means the seller has no taxable gain on that portion (since it’s not sold for more than its cost). Both parties may agree on how cost is determined – e.g. using the supplier invoices, or the weighted average cost on the books, etc.. (Sometimes, if inventory is composed of finished goods, they might agree on a percentage of retail or an appraisal, but cost is most common.)
- Handling Excess Inventory: What if the business has far more inventory than “normal”? Buyers might be reluctant to tie up extra cash in surplus stock that isn’t needed immediately. The agreement can address this by saying, for instance, the buyer will only be obligated to buy up to a certain dollar amount of inventory (the normal level). If the seller has accumulated more than that, the buyer might either exclude the excess, or purchase it separately if they choose. This is negotiable – in some cases buyers do purchase the extra inventory but often at a discounted rate, or the seller agrees to keep or liquidate the excess post-closing.
- Obsolete or Unsellable Inventory: Not all inventory is created equal. Aged, expired, or obsolete inventory is a special case and usually will not be paid at full cost (or at all) by a savvy buyer. During the pre-closing inventory review, the buyer will inspect for items that are unsellable or very slow-moving. The contract might stipulate that obsolete inventory will be excluded or priced at a steep discount. For example, the seller might have to either dispose of those items, or the buyer might take them but only pay a fraction of cost, or perhaps pay the seller for them as they are sold in the future. Another solution is the seller financing a portion of such inventory – essentially leaving some inventory value on an IOU that gets paid only if that inventory generates revenue later. The goal is to ensure the buyer isn’t paying today for inventory that might never turn into cash. As a seller, it’s wise to address this upfront: if you have old inventory, expect that the buyer will identify it and negotiate its treatment. Often, cleaning it up before sale (as mentioned earlier) yields a cleaner deal.
- Work-in-Process (WIP) and Raw Materials: In some asset sales, especially manufacturing businesses, inventory isn’t just finished goods on a shelf. You may have raw materials, work-in-process (WIP), and finished goods – all of which need handling. The purchase agreement should clarify how WIP is valued. Usually, WIP valuation includes not just raw material cost but also the labor and overhead incurred up to that point. This can be more complex to calculate, so sometimes a separate line item or method is agreed (for example, doing a cut-off where the buyer pays for raw materials and a percentage of value for partially completed items based on stage of completion). Raw materials are often counted and valued like other inventory (at cost), while finished goods are just inventory ready for sale. The key is to avoid double-counting or omission – make sure everything is categorized and accounted for so both parties know what’s being paid for.
- Responsibility for the Count: A practical aspect – who actually conducts the inventory count? Many purchase agreements spell out whether it’s the seller’s team, the buyer’s team, or a joint effort (sometimes an independent inventory service is hired). Joint counts or third-party counts are common to prevent any bias. The contract might also specify how disputes in count or valuation are resolved, perhaps by a neutral auditor.
In summary, an asset sale will have detailed clauses on inventory because the buyer only gets what’s defined. It usually involves a pre-closing count, valuing inventory at cost, adjusting the price for differences, and special treatment for obsolete or excessive stock. In many ways, this mirrors the working capital adjustment concept in share sales – both aim to ensure the buyer gets a fair amount of working stock and the seller is paid appropriately for what they deliver.
Ensuring a Smooth Transition and Fair Deal
Regardless of deal structure, both buyer and seller should keep a few best practices in mind to handle inventory properly in a business sale:
- Plan and Communicate Early: Inventory issues should be discussed early in negotiations. Agree on what a “normal” inventory level is, how it will be valued, and outline the approach in a letter of intent (LOI) or term sheet if possible. Surprises at closing about inventory can strain or even derail a deal, so get on the same page well in advance.
- Maintain Normal Operations: Once you have a target inventory or working capital agreed, the seller should operate the business normally leading up to closing. Don’t run down the inventory to save money, and conversely don’t stockpile dramatically unless it’s needed for sales. Buyers will be watching inventory levels between signing and closing – in fact, agreements often require the seller to maintain inventory in the ordinary course. Big swings can trigger concerns or even contract breaches. If changes in inventory levels do occur (e.g., due to unexpected supply issues or a spike in sales), communicate with the buyer and remember the adjustment mechanism will account for it.
- Accurate Records: Make sure your inventory records are accurate and up-to-date. Perform cycle counts or a full count before going to market, so that when the buyer examines your inventory, it matches what’s on the books. Inconsistencies between recorded and actual inventory can reduce trust and value. If you use an ERP or inventory management system, have reports ready to show inventory aging, turnover, and costing method.
- Addressing Inventory Accounting: Agree on the accounting treatment for inventory in the transaction. This includes methods like FIFO vs. LIFO (which can affect valuation) and whether any reserves for obsolescence will be applied. As noted earlier, using consistent methods for target and closing calculations is crucial. If you as a seller have not been reserving for slow-moving stock but the buyer wants to value inventory more conservatively, you may need to negotiate an adjustment to the target or simply clean out that slow stock beforehand.
- Utilize Professional Help: Consider hiring a professional inventory counting service for the closing inventory count, especially for larger businesses or those with lots of SKUs. It can speed up the process and add credibility to the numbers. Also, involve your accountant to help determine normalised working capital and assist in any true-up calculations. These can get technical, and having financial experts on each side will ensure the math is done right.
- Legal Clauses for Protection: Both sides should ensure the purchase agreement contains clear protections regarding inventory. For buyers, reps and warranties from the seller that inventory is usable/saleable in the ordinary course (except any disclosed obsolete items) are important. This gives recourse if, after closing, it turns out a big chunk of inventory was unsellable junk that wasn’t disclosed. For sellers, if you know you have some older inventory the buyer is concerned about, you might negotiate terms like the buyer will pay you for that inventory only when it’s sold (or return it if unsold after a period). Everything should be written down to avoid ambiguity.
By handling these aspects diligently, both buyers and sellers can ensure inventory is fairly accounted for, which leads to a fair purchase price and a smooth transition. The buyer walks into ownership with the stock they need and no immediate shortages, and the seller walks away knowing they got paid for the inventory they handed over (aside from any agreed discounts for obsolete items). Since inventory directly impacts a company’s ability to generate revenue, getting this right helps the business continue without hiccups under new ownership.
Final Thoughts
Inventory may just be one line on the balance sheet, but in a business sale it deserves special attention. It’s tied to working capital, which in turn can swing a deal’s price by a substantial amount. Whether your deal is structured as a share sale with a net working capital adjustment, or an asset sale with a counted inventory payout, understanding the norms and expectations is crucial. Both parties should strive for transparency: disclose what the inventory consists of, agree on what’s included in the sale, and verify everything through counts and audits. When handled properly, inventory will simply transfer as part of the business without drama, allowing buyer and seller to focus on the bigger picture of the transition.
If you’re planning to sell your business, start thinking about your inventory now. Clean it up and get your records in order. Determine what a normal level is for a buyer to take over. And work with your advisors to set the right targets and contract terms. This preparation can prevent costly disputes (working capital fights are one of the most common post-closing disputes in M&A) and ensure you don’t leave money on the table by undervaluing your stock.
Lastly, always seek professional guidance when in doubt. Inventory and working capital adjustments can be complex, but experienced M&A advisors, business brokers, and accountants have seen it all before. They can help structure the deal so that both you and the buyer feel confident about the inventory component.
Ready to take the next step? Whether you’re selling a small retail business or a large manufacturing company, handling inventory correctly can make or break your deal. Don’t navigate this process alone. Consider reaching out for a professional consultation and guidance on preparing your business for sale, which includes a checklist for inventory management during a sale. By leveraging expert advice and planning ahead, you can maximize the value of your inventory and ensure a successful business sale.