How Inventory Is Handled in a Transaction

Handling inventory is a critical aspect that requires careful consideration in an M&A transaction in order to ensure an accurate valuation and smooth transition. Inventory is also a crucial component of working capital and is treated with particular attention due to its direct impact on the valuation and the final purchase price adjustment.

During due diligence, the buyer will conduct a thorough review of the seller’s inventory to assess its value. This typically involves verifying the quantity, quality and condition of the inventory as well as identifying any obsolete or slow-moving inventory. The buyer may seek adjustments or write-offs for such inventory. The buyer may also examine the seller’s inventory accounting methods to ensure consistency and accuracy. The buyer and seller will agree on the valuation method for the inventory which can be based on book value, market value or a negotiated value. If there are significant discrepancies between the book value and the actual value of the inventory, the purchase price may be adjusted accordingly.

As part of the M&A negotiation, the buyer and seller agree on a target level of working capital, which includes inventory. This target is usually based on historical averages or specific operational needs. Any adjustments to inventory can affect the overall working capital adjustment in the purchase agreement. Transitional arrangements may be made to manage the inventory during the period between signing and closing. This can include agreements on how inventory will be managed, accounted for and reported during this period.

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The treatment of inventory can have legal and tax implications, so it’s important for the seller to consult with legal and tax advisors. The purchase agreement typically includes warranties and representations regarding the condition and value of the inventory, providing protection for the buyer against undisclosed issues. Effective planning and communication are key for a smooth transition and integration of inventory management practices between the two companies.

At closing, the actual working capital, including inventory, is compared to the target working capital. If the actual working capital is higher than the target, the purchase price may be adjusted upwards; if lower, the purchase price may be adjusted downwards. A physical inventory count may be conducted at the closing date to verify the inventory levels. This can be done jointly by both parties to ensure transparency. The transfer of inventory ownership is executed as part of the overall asset transfer which includes updating inventory records and systems to reflect the new ownership. Integrating the inventory management systems, processes, and practices of the two companies is essential for seamless operations post-transaction. This may involve harmonizing inventory control systems, reordering processes, and warehousing practices.

Post- acquisition, the buyer may seek to integrate and optimize the inventory management practices of the acquired company. This could involve aligning inventory policies, systems and processes with those of the buyer to achieve efficiencies and synergies.

By addressing all of these aspects carefully, both buyers and sellers can ensure that the inventory is accurately valued and efficiently integrated. Proper handling of inventory, from valuation and verification to post-closing adjustments, ensures a fair transaction and smooth integration for both parties involved.

Author

Amy Alonso, Managing Director, Benchmark International

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