Paul was excited about the impending purchase of the auto parts store he had found for sale after several months of looking for a profitable business to buy. He liked the location, the looks of the place, the lease, and he was pleased with the recent jump in profitability shown on the P&L that he reviewed, once he started his due diligence.
So Paul was a little annoyed at the delay in moving the deal forward, when his accountant insisted on seeing a few years of the company's balance sheets, and the seller objected.
"That has nothing to do with it," the seller insisted. "The balance sheet just shows what I have invested in the business and what I owe."
And, the seller said: "You'll get everything free and clear, so it doesn't matter what my business assets and liabilities are. You'll start with a clean slate."
It is fortunate for Paul that his accountant prevailed. After a few minutes of looking at the values of assets and liabilities for the business going back three years, the accountant was troubled by something-the fact that the inventory figure, listed in the assets column, had not changed.
"Does it look like there is $200,000 worth of inventory in the store?" he asked his client.
Paul said he wasn't sure about the total value, but it appeared there were a lot of empty places on the shelves in the parts room. And Paul mentioned that when he asked the seller about it, he was told that it didn't matter how much there was in auto parts on hand, because their deal called for the value of the inventory, at cost, to be paid for in addition to the purchase price.
"This way," the seller had told Paul, "You can start out lean and mean, and just add the inventory you want."
Business brokers and seasoned buyers will quickly realize-just with these facts-what had the accountant so worried.
A reduction in the amount of actual inventory on the shelves, without an accurate accounting on the balance sheet showing the reduction in value from a prior year, obscures the fact that the business owner has been selling stock without replacing it. The result, of course, is that it appears his gross profits have increased. With sales the same, from year to year, but cost of goods declining, the seller can try and convince a prospective buyer that the company is becoming increasingly profitable. That's the way it appeared on the profit and loss statement of the auto parts company.
The deal quickly unraveled when the seller refused to agree to Paul's request that they conduct a physical count and valuation of inventory to verify that figures on the balance sheet were accurate.
This story serves to illustrate that people eager to purchase a business for sale, without a grounding in the basics of business accounting, are well advised to call in an expert to help examine the records of the company being considered for purchase. That's what Paul did.
MISCELLANEOUS INCOME
Don and Heidi weren't as lucky, or as smart. Maybe they just were so enamored by the idea of owning a pet store that they allowed their excitement to interfere with good judgment.
They too were told by the seller that all they needed to see was the profit and loss statement. Lacking business experience, and not wanting to upset the seller-perhaps lose the deal--Don and Heidi didn't press the matter.
In fact, it wasn't until a few months after close of escrow, when the judge heard the civil lawsuit that Don and Heidi brought against the seller-charging misrepresentation and unfair dealing, that the full story came out.
Heidi explained to the court that she'd asked the seller about the item called "miscellaneous income" listed for $19,000 on the business profit and loss statement.
"The seller told me it was a category for several things like credits and rebates that we would get from suppliers."
But when the balance sheet was subpoenaed into evidence and examined, the judge noticed, in the liability column, a recent loan to the company for $19,000 from the seller's mother. The seller's CPA, wanting to make sure the item was accounted for according to proper accounting procedures, had made the entry on the P & L, which-- with the seller's lie--helped to close a sale of the business to Don and Heidi.
The judge complimented the seller for scrupulous bookkeeping, then told her she owed the buyers $30,000 to cover their claim of loss, plus penalties.
THE TELLTALE LIABILITY
The machine shop owner who made a deal to sell his business was quite willing to turn over the company's balance sheets along with the profit and loss statements for examination during the buyer's due diligence. Perhaps he didn't think prospective buyers would care about his growing obligation to a major supplier, the chrome plating company that provided thousands of dollars in service for the machine shop each month.
At some point, when the machine shop owner was short of cash, he had worked out a deal with the plater to pay for half the work in cash upon delivery, and to add the unpaid portion to the promissory note payable to the supplier.
"It doesn't matter," the seller explained to the buyer. "It's my obligation and I'll pay it when we close escrow."
But the buyer wasn't buying that line of reasoning-or the business for that matter.
The profit and loss statement, by not reflecting the total cost of the outside labor, made it appear the business was more profitable than the facts revealed. The buyer was smart enough to request the full set of books. And he immediately spotted, tucked into the liabilities column, the shop's true costs.
While most buyers have the good sense to question a seller closely on every item in the company's books, and then bring in an advisor for a second, professional opinion, some people are intimidated by the process of purchasing a small business. They might be so excited by the idea that they forget to use extreme caution in analyzing the offering. That was the case with Don and Heidi. In some cases, the prospective buyer, embarking on a new life as a business owner, believes it's important to act like Donald Trump, and not reveal just how little he, or she really knows.
What these stories illustrate--both as cautionary examples for "newbies," and as reminders for experienced business people--is the importance of seeing the total financial report on a company being considered for purchase. |
 |
|
|
Peter Siegel, MBA - BizBen Founder, Author, Consultant
Peter Siegel, MBA is the founder and President of BizBen.com - Businesses For Sale In California. A nationally recognized author (3 books and a syndicated small business blog) and expert consultant (national SBA small business specialist) on selling and buying businesses, he provides professional assistance to business brokers, agents, and business owners in getting maximum response in their advertising & marketing efforts in regards to selling small to mid-sized businesses. If you are selling a business and need professional assistance utilizing high performance advertising, marketing, and highly effective strategies, or individual customization with your BizBen Power Search options in buying a California business, you can reach him at 866-270-6278.
|
 |
|
