[EP 264] Ask Me Anything with David Ferraz | Strategies for Handling WIP & Unexpected Stock Valuations in Business Sale Negotiations

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Joanna:

Hi, it’s Joanna Oakey here and welcome back to The Deal Room Podcast, a podcast proudly brought to you by our commercial legal practice Aspect Legal. Now, today we’re stirring things up a bit with another of our special segments. It’s time for another thrilling episode of Ask Me Anything. Now, if you’re new to the Deal Room podcast, let me give you a quick rundown. Our Ask Me Anything segment is where I dive into the questions that you, our incredible listeners, send in, and not just your questions. We also feature queries from our fabulous guests and those interesting nuggets we encounter during our day to day practice. So here’s your chance to have your burning questions answered. Email us at [email protected] au. We’re eagerly awaiting your queries. And don’t worry, you’ll find the link in the show notes to that for easy access as well. So look, don’t hold back. We’re open to talking about anything and everything on this podcast. So buckle in because it’s time for another thrilling edition of Ask Me Anything. Okay, David. Welcome along to the Ask Me anything section. This is where you get to ask me something. OK, so David, what did you come with today? Throw it at me.

David:

All right, let’s see if I can stump you there.

Joanna:

Give it a go. Let’s see.

David:

Firstly, what we’ve encountered sometimes in business sales, we get all the way to settlement day. Well, the day before settlement and the stock take is done. And lo and behold, the stock comes in at a massive figure that is way beyond what either the buyer or seller had been expecting. And the buyer hadn’t budgeted even for such a big number, and it’s just not possible to actually settle on that number. Have you got any tips on how one could try and get around that roadblock?

Joanna:

Yeah, absolutely. Well, obviously, right in the beginning, it begins with preparation. Sellers should do everything that they can to ensure that they have a really clear understanding of the stock levels. And that all comes back to systems and processes. In a previous episode, we recorded, David, we talked about the importance of systems and processes in a business as you’re nearing sale. Obviously, the system of keeping stock records and doing regular stock takes and having done a stock take before sale is really important so that you know what you’re dealing with and you’ve got records in your system that are doing the work rather than you having to do counts to work out what your stock is regularly. But that having been let’s put that to the side. If, say, for example, there’s been an issue with the preparation that hasn’t been done or whatever. What do we do within sorry, just one other thing. I would say also dealing with it at contract stage. It’s good to deal with it at contract stage for a buyer.

If you’re looking at it from a buyer perspective to ensure that you’ve got a maximum stock price that you’re not required to buy above. And for sellers it’s making sure that there’s at least an agreement as to the amount that a buyer, sorry, is willing to buy. So all of that should be dealt with up front and in the contract. But if you get to stock tape day and the reality is there’s a hell of a lot more stock than anyone had anticipated and dealt with in the contract. I guess you’ve got a number of options. It depends the quality of the stock because if there’s damaged stock, obsolete stock, stock that isn’t going to sell essentially it’s probably fairly fair for a buyer to be pushing back on that sort of stock or requiring some sort of heavy discount. Of course, from a seller’s perspective, usually they’re in the position that they’ve got no one else to flog this stock off to, so they want it sold at the point of sale. They want to liquidate it in some way, shape or form and take their bucks away.

But if we’re looking for creative solutions, I’ve actually seen lots and news, lots and lots of different creative solutions. So some of the ways that we might deal with it is we deal with a stock that’s been agreed and then any of the overflow stock, assuming it’s good and saleable stock and it’s not too old, is some way once, or in many instances, I’ve used a consignment approach where we say, okay, well, we will effectively leave this additional stock with you on assignment, and there’s going to be an agreement that you’ll sell the consignment stock in advance of selling any of the other stocks. And then we have a monthly reporting. But of course, along with that comes the requirement that there’s some sort of management of the stock counting and sale process within that. Because of course you need to know what stocks moved so that you can then report on it so that the buyer can report on it to the seller and that the seller is paid for that consignment stock that’s been sold. So that’s one approach.

Another approach is obviously that the seller finds someone else to sell the excess stock to. But as we all know, that is easier talked about than done. In many instances, depending on how specialized the stock is, sometimes we use vendor financing components. So it might just be, well, we agree on the certain stock that’s there you pay buyer for what you’ve agreed in advance, but the remainder components rather than being on consignment. And consignment of course means that the seller isn’t paid unless that stock is cleared.

Alternatively, we might just say, okay, well, that is now a loan from us that you must pay buyer. But here’s the payment arrangements for that on the understanding that you may not have finance for that or the funds for that at completion because you hadn’t budgeted for that. And sometimes what we’ll see is a discount on that additional stock because sometimes that cost of holding that stock sort of whittles away, I guess the value of the stock as well. So they’re things that I’ve seen. What else have you seen, David? I’m interested in approaches you’ve used.

David:

Well, it’s interesting because I’ve often actually brought up that idea of the consignment and for some reason or other people seem to have been more resistant, but they’ve worked out something similar. So it’s more like your second scenario where the stock is taken over maybe three or four months at a certain amount per month. So essentially they would have had to buy it from suppliers over that time anyway, so that vendor becomes the supplier, I guess, but it’s not dependent on a stock take, it’s just the amounts divided up.

Joanna:

I like the consignment approach, but it has issues. If there’s not sufficient checks and measures in the business to be able to easily record work out what the stock movement has been in a particular month, that then leads to the payment. So in those sorts of businesses you probably really are left with that second approach that I talked about.

David:

But I like the consignment as well in theory, because the ownership of their stock is with the vendor. So that sorts out a security issue for the loan.

Joanna:

Absolutely, 100% absolutely. And that is actually the driving force sometimes for you, the consignment approach. Yeah, absolutely. Because title remains with the seller. Brilliant. Well, that’s doc and we have room for one more. Ask me anything. So did you come with anything here, David, that you wanted to test me on?

David:

So, because we’re talking about industrial businesses again, so manufacturing up pops the issue of work in progress. So in my experience, work in progress is a very hard to nail down value. How do you value work in progress in a sale and so how you think that should be dealt with in terms of the contract and setting rules for the valuation of the work in progress and the process.

Joanna:

Work in progress can be a really tricky one, not just for businesses that relate to goods, so where work in progress relates to the goods themselves, but also service-based business. Because Whip is also an issue in service based businesses wherever you have a part supplied service at the point of completion. And it’s just always this in each instance, it’s about sitting down and understanding how the business works, where the costs have occurred and when the revenue is realized. Because some of those in some businesses that is not a straightforward thing. So there may be milestone payments or there might be part delivery. In some businesses there’s a clear revenue point I e. For manufacturing. The goods have been manufactured and delivered and that’s the revenue point. But at this point of completion we have partly manufactured goods and of course that can be a whole headache in and of itself.

I don’t think I’ve got any hard and fast rules other than we just sit down and we have to work out the mechanics for each deal on the basis of how the business actually works and what their expense and revenue sort of milestones look like. And sometimes in some business sales it’s really about us coming up with, well here’s the metrics and let’s just estimate what it’s likely to be just before the point. Sometimes it’s just easy to set a dollar figure rather than trying to work out a complex formula. Sometimes you need a that’s unfortunately I don’t have an absolute answer for you here David. It really is something that we have to work through on a business by business basis. How about you? What tips do you have here?

David:

Well, what I’ve seen and what the approach I often use is to say to both parties, look, that it’s not an exact science and there’s going to be need to be a little bit of common sense negotiation around the table. So you might sort of sit down on settlement day and hopefully there are only two or three jobs that are actually stuck in work in progress phase. And then you’d sort of say to them, okay, let’s try and work out percentage wise of this job. Somebody might have ordered some materials and started to assemble something but it’s still got to have this assembly completed and then it’s got to be painted and then shipped and delivered.

So where is it? And approximately what percentage of the input has been put in by the seller and what percentage of that job has been done will have to be done by the buyer. So then might say, okay, the vendors put in 50% of that so they’ll get 50% of the invoice value and then the buyer will then collect the rest of it, the whole thing.

So 50% belongs to the buyer and then they just work through each of the jobs on the table because you can’t get precision on that. It’s not exact. The other thing that I have seen is where people have set some rules prior to settlement where they’ve said, okay, if a job has the vendors actually got the order and they haven’t started production, then nothing’s paid because the buyer expects to get some jobs.

If they’ve started the job, it might be 50% if they’ve completed the job but it’s still going to be dispatched. They might say 90% belongs to the vendor and 10% to the buyer because they’ve still got to pick and pack and order the courier and so on and send that out and then they just apply the rule at Settlement based on what the structure is. But yeah, as you say, it’s got to be tailor made to each deal, really, and each business.

Joanna:

Absolutely. And sometimes we see issues come to the fore if the parties haven’t early enough in the piece, thought about the interplay and all of that of things like customer deposits or prepaid expenses or post completion required expenses that hadn’t initially been thought about by the buy. So it’s just really important to work each of those areas through with a little bit of thought as to what it will actually look like when you’re trying to work it out on Completion Day, because you certainly don’t want to leave it to Completion Day to work out the mechanics of how that’s going to work. Because I could tell you that in shorter ending arguments.

Well, that’s it for this episode of The Deal Room Podcast. We hope you’re now primed for your next deal with these pointers and have enjoyed these fascinating insights. Now, if you’d like more information about this topic, then head over to our [email protected], where you’ll be able to download a transcript of this episode as well as access any contact details and any other additional information we referred to in today’s podcast. Now, if you’d like to get in contact with our guests today and the services they offer, you can go ahead and check out our show notes for a link right through to them and their details. You can also book in directly with our Legal Legals at aspect Legal.

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