Toy store due diligence

Once a letter of intent is signed, the buyer’s job changes from judging a toy store to verifying one. The documents requested should test the claims the price rests on: that holiday-quarter sales are real, that the stock on the shelves is sellable, that the retailer has met its federal product-safety obligations, and that nothing is registered against the assets or hidden in the lease. Each section below names a check, the document or registry behind it and the question a finding raises. The order runs from money to paper.

Reconcile the till, the bank and the filings

Start with the holiday quarter if it carries a large share of the year’s sales. Point-of-sale reports by category should reconcile to bank deposits and to the GST/HST and income tax filings for the same months, with returns, gift-card redemptions and layaway accounts shown separately. A gap is not necessarily wrongdoing, because online orders, marketplace payouts and refunds can all create timing differences, but an unexplained one leaves the earnings figure unverified. The answer on verifying a seller’s financials covers the general method.

Count the stock by season and by licence

A physical count by category, rather than a single total, lets the buyer compare each part with the books. Seasonal assortments and licensed tie-in lines can be tallied apart from evergreen stock, with age and condition noted, so each category can be valued on its own. A gap between the book figure and the counted figure is a question to put to the seller. The agreed closing-day method then turns the count into a price adjustment, as described in how a post-closing working-capital adjustment works.

Ask for the retailer’s product-safety file

The Canada Consumer Product Safety Act sets the standard here. A retailer must prepare and maintain documents showing the person it obtained each product from and the location where and period during which it sold the product, and must keep them until six years after the end of the year to which they relate unless another period is prescribed (section 13). Ask to see them for the lines now on the shelves and for lines sold in recent years, then compare the stock list against current recall notices. If a seller cannot produce supplier-and-period records for a line, ask how they will be rebuilt before closing.

Check what is on the box and in the advertising

Where the store imports directly or sells under its own label, labels and claims become part of the file. The Consumer Packaging and Labelling Act applies to a dealer, defined as a retailer, manufacturer, processor or producer of a product, or a person engaged in the business of importing, packing or selling any product. Subject to exemptions the regulations can make, it bars a dealer from selling, importing or advertising a prepackaged product unless it carries a label with the required net-quantity declaration, and from applying to a prepackaged product, or selling, importing or advertising one that carries, a label with a false or misleading representation relating to the product, which includes a description of its type, quality, performance or function that may reasonably be regarded as likely to deceive a consumer. The Competition Act separately makes it against the law to advertise or market something in a way that is false or misleading, so a sample of the directly imported lines, read against both, is the practical test.

Search for liens and read the lease

Inventory and fixtures can be pledged as collateral, so a security search belongs beside the stock count. Ontario’s Personal Property Security Registration system holds financing statements that potential lenders and buyers can search, and the province’s guidance to buyers of used goods is to search first and, where a loan has been repaid, to insist that the seller require the lender to register a discharge before the sale is completed. That is an Ontario system; for a store in another province, search that province’s registry. The answer on checking for liens explains the process. The lease comes next. Under Ontario’s Commercial Tenancies Act, section 23, a covenant against assigning without consent is deemed subject to a proviso that consent is not to be unreasonably withheld unless the lease contains an express provision to the contrary, so the lease’s own wording matters.

What each finding raises

Each finding raises a question for the purchase agreement or the price. The list below sets out the question that each one raises.

• A registered lien on inventory: the lender may have rights in the stock until a discharge is registered, so ask how and when it will be discharged.
• Deposits that fall short of reported holiday sales: the earnings figure stays unverified until the gap is explained.
• No supplier-and-period records for a current line: the section 13 file is incomplete for that line, so ask how it will be rebuilt.
• A supplier that will not confirm an allocation for the new owner: ask whether the price assumes that line.
• Stock tied to a recall that was never pulled: section 8 bars anyone who knows of the recall from selling it, so the agreement can say who bears the cost.