Business Due Diligence or a Seller Warranty? Which is Better…

The seller told the buyer “The books do not show all the money, but I guarantee you that this business will clear $10,000 a month after taxes.”

How often have you heard these words? Wouldn’t it be great if you could actually get a guarantee from a seller when buying a business? You can. But you have to ask for it, and you have to give the seller a good reason for them to give it to you.  I assure you a seller can have a lot of good reasons for not wanting to give it — and some are totally legitimate.

So, when are you justified in asking?

There are several conditions to look for.

As an example, a client of mine, a buyer who was buying a gardening business: His spouse was controlling the billing and collection,  spending business funds on personal expenses to the extent that the husband could not determine with much accuracy the profit for his own company. The buyer wanted to buy anyway, and I insisted he would need six months’ worth of books without the wife controlling them in order to work out a trustworthy profit number. I suggested they transfer the ownership for a reasonable basic price, but with the caveat in the purchase contract that  additional moneys would be paid to the seller based on the actual profit from six months of operations. This guaranteed the buyer he would not overpay due to incomplete information. Everyone was happy.

Another indication that a warranty or guarantee would be helpful is when the seller tells the buyer that “there is cash income that cannot be proven.” This is a not true; 80% of the time doing due diligence I have successfully proven the cash, and the deal moved forward. The 20%, of the time that your CPA or due diligence expert tells you the books cannot be verified, that is when to ask for a warranty.

Nota Bene: Do not take a guarantee/warranty in place of doing due diligence. On the rare occasion that the seller is a real crook, he won’t mind a little lie, too. He’d be perfectly all right with giving a  warranty/guarantee to a buyer in order to gain their confidence. Crooks do this knowing the buyer will never be able to collect on it. I have just been reviewing a court case in which the crook seller knew the financials he provided were a fraud, but he knowingly gave a bogus guarantee to the buyer anyway in order to close the deal. The buyer’s CPA had reviewed the books; he could not verify them and had told the buyer to walk away. But, why shouldn’t the crook lie? The criminal mind does not look at the possibility of getting caught, so this does not stop him from giving a guarantee. In this particular court case, the sale was cancelled and the buyer was awarded his down payment back, legal fees and damages. But, we do not know if the buyer ever collected on the judgment. Based on what I’ve seen in too many cases, the seller and money probably disappeared when it came time to pay up.

The best protection against fraud is having a detailed due diligence completed by a trained expert,  and then, if the business does not pass the test, get out without any further entanglement.

Of course, if you are buying the business regardless of the outcome of your due diligence, then a warranty or guarantee is just another benefit to your side of the sale.

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Image credit:  abluecup iStock

 

 

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