I read with interest an April 23, 2008 report titled “Millions Involved in Local Business Buyout Scam” published in the Christian County Headliner News. As a certified public accountant who has represented buyers/sellers in commercial sales transactions and also as managing partner of Sunbelt Business Advisors, a commercial brokerage firm, I thought it would be beneficial to write about the many red flags that were present in the article. Red flags that others should be aware of and protect against when trying to sell or buy a business.
SMALL BUSINESSES ARE NORMALLY SOLD AS A PURCHASE OF ASSETS AND NOT AS A PURCHASE OF SHARES. This transaction appears to have been a stock purchase and not an asset purchase. This should have been one of the first very big red flags. Small private companies are almost never sold as stock purchases. A stock purchase means that the legal entity of the current owners, the company, continues rather than the new buyer creating a new company. In a stock purchase, the new owners get everything the business owns from the sellers: bank accounts, accounts receivable, any potential and actual liabilities. This includes contingent liabilities that the new owner may not even know about. In addition, a stock purchase does not allow a new owner to increase the base of the company’s furniture, fixtures and equipment. FF&E’s improved foundation could mean thousands of dollars in tax savings for a new owner that would be highly beneficial during the first few years of ownership. It is almost unheard of for a buyer to walk in and immediately want to buy the stock of the business and assume all liabilities, possible future liabilities, known or unknown, and leave additional depreciation on the table. A normal asset purchase agreement (not a stock purchase) would generally have excluded the previous company’s cash and bank accounts. The new owners in an asset purchase agreement, unlike a stock purchase, would not have been able to transfer funds from company accounts. They would have to open new bank accounts in the name of their new company.
AT CLOSING, BUYERS’ FUNDS MUST BE AVAILABLE. Apparently this deal closed without confirmation or having actual funds from the buyer. No business purchase transaction should be closed without having funds available and present at the time of closing. This would be the same as selling your home to someone, closing the deal, but the buyers are not yet approved for the loan. You wouldn’t and neither should small business sellers.
ALWAYS USE A QUALIFIED CLOSING ATTORNEY. The sale of a business must be closed by a qualified closing attorney. Qualified closing attorneys will have their own space and will not normally need to use other space. A qualified closing attorney will make sure all legal documents are in order; make sure there are funds available to pay the seller and submit all required IRS and legal documents. Anyone selling or buying a business should insist that a qualified closing attorney perform the closing. The absence of a qualified closing attorney should be a red flag.
USE A QUALIFIED BUSINESS BROKER – DON’T TRY IT ALONE. Not using a qualified and professional trading broker is another red flag. Can trades be completed without using a trade broker? Certainly! You can also write your own contracts without using a lawyer or prepare your own tax return without using a CPA, but it’s not necessarily the smart thing to do. Especially when talking about the sale of a business which is probably one of the largest assets, if not the largest, that a person owns. Something as important as this should not be attempted alone. A qualified business broker will help educate the seller on the process, help establish a valid market price, market the business effectively, screen buyers and help qualify buyers, assist with negotiations, work with the CPA and the existing seller’s attorney and will work with the closing. lawyer and the general management of the process and being there to advise the seller regarding red flags.
NEVER CHANGE BANK ACCOUNTS UNTIL YOU HAVE YOUR MONEY. Another subtle, but still red, red flag is that it appears that the seller changed the signature cards at the banks and the names of the people allowed access. Even in a stock purchase, the current bank account holder, the seller, would have to have the bank change names and cards. Obviously, if this really happened, it happened before the seller got any funds from the buyer. Apparently, the new buyer also had the “keys” to the business before the purchase price was paid to the seller. It’s like selling your car to someone and agreeing to get paid at a future date; as he watches the “new buyers” he just met drive off into the sunset in his car. He will probably never see his money or his car.
Most small business stories like your article are not public. Just like most financial fraud that occurs in small businesses. People don’t like to talk about small business transaction failures, but they happen all the time and all over the country. It is very important that sellers and buyers understand the process of buying/selling a business, be aware of the red flags and use qualified professionals to help them through the process. Doing so will save them money, time and effort and will make the business transaction that much better.
