We are often approached on behalf of purchasers of businesses which are not as profitable as they were under the control of the vendor.
This can be due to numerous reasons, many of which may have no sinister implications at all (e.g. the client should never have bought that type of business in the first place – Basil Fawlty really should not be running a hotel!). Alternatively, has the purchaser been sold a pup and it has slipped through the due diligence process.
Of course, everyone would like to think they are able to conduct a business they have selected and purchased for themselves better than their predecessor, which means that when things don’t go according to plan, they are looking for answers. In order to determine whether there have been any misrepresentations by the vendor it is necessary to access the numbers behind the financials prepared for sale purposes. This can be achieved a number of ways, however retaining all information provided by the vendor in the due diligence process is a good start.
We have been engaged a number of times to conduct such a review where the vendor has either left behind all the financial data on their computer hard drive or even better, left behind records which indicated that there were two sets of books. This sort of information can be invaluable when determining whether the purchaser has any case or whether the problem is related to the general economic climate or just lack of entrepreneurial skills.
Once it has been established that the vendor has a case to answer, it becomes necessary to quantify what the purchasers claim may be.
In a number of our matters, vendors have operated businesses under the one corporate entity which have several branches. When it came time to sell the business, the vendor was only selling one branch or part of the business. In preparing the financials to support the sale price, income from all branches was included in the figures, however expenses were only included for the branch or component of the business which was being sold. One does not have to be a mathematical genius to realise that the profit expectations of a purchaser presented with those financials may be greater that what can actually be achieved.
In scenarios such as this, it is necessary to effectively re-value the value of the business based on the correct financial information – the difference between the amount paid and the revaluation can often form the first component of a claim by the purchaser. Additional losses can be in the form of actual trading losses incurred by the purchaser after settlement; costs of additional finance required to prop up the business; or capital expenditure incurred in an attempt to mitigate losses.
It is imperative that when purchasing a business, appropriate due diligence is undertaken by parties with the appropriate qualifications. It may cost the purchaser more, however if it avoids them financial and emotional heartache in the future, it is money well spent – after all, who would purchase a million dollar property without engaging a qualified building and pest inspector!
When purchasing a business, remember the phrase – Caveat emptor!