Due Diligence Case Study

Due Diligence Case Study: Poor Bookkeeping Leads to Confusion

This is a true story of one of my due diligence assignments regarding a thief operating from within a tree trimming and landscaping company in Northern California.

Business Sale Stalls when Financial Records Don’t Add Up

Michael was very interested in owning his own business and his best friend Charles was going to work in the business with him. Michael had a very good government day job and could not afford to give it up for a few years. He was trying to figure out who was going to run the business after he bought it.

Michael and Charles were looking at a landscaping and tree trimming business to purchase. I was brought in to review the financial records and perform due diligence to determine what the real profitability of the company was.

Poor Bookkeeping Keeps Everyone in the Dark

The business owner’s wife did the bookkeeping for the company; however, the books were a complete mess. The books were a mess because the owner’s wife was using the business as her personal slot machine. HUNH? She kept the invoicing and posting of accounts receivable so mixed up that her husband could not figure out how much money they were making or how much she was taking out of the business. John, the business owner, would work harder and harder and still not see any money available for expansion or for himself.

This poor husband had been trying to get a handle on the books for 10 years without success. He finally, 6 months ago, put his foot down and said he was bringing in a CPA to take over the books from his wife.  Her response to losing control of the cash cow was to announce she was getting a divorce.

How to Determine Profitability when Bookkeeping has Failed

The owner/seller did worksheets to try and figure out what the real profit was but he could not be sure, and I, having been brought in to perform the due diligence investigation, could not trust his guesses. My solution was to get the books away from the wife and after 90 days of independent record keeping we could determine a price. That price was to be determined based on a multiple of the annualized profit. I reasoned that this way the buyer and seller could make a deal now, without my having completed any extensive financial review.

The Results of the Financial Due Diligence

The deal was stuck. The seller went on salary, and as of publication was still running the company. The wife is off the bank accounts, and not handling the books at all. The buyer is investing working capital to cover expenses that the wife did not pay. The price kept going down during negotiations because the company was getting smaller and smaller and back bills kept getting larger and larger. As expected, my review showed the wife was draining the company as much as she could before leaving the company.

The buyer and seller are working well together and all is well with the trees.

I believe this partnership of the new owner and the old owner will work out fine. The seller is free of his wife and has no more confusion on how much the company is making, and can continue to do what he loves; running the company. The buyer now owns a business, which he can work evening and weekends while keeping his day job.

At least for now, everyone is happy.

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