Despite stringent disclosure rules which aim to even things up between the supposedly rapacious seller and the innocent purchaser, it’s very easy for a buyer of a small family business to be caught by buying a dud.

If you’re stuck with a dud business as a result of being deliberately deceived you certainly can take them to court. But you don’t need me to tell you of the costs of litigation, the time it takes (years!), and the very real chance you may not succeed anyway.

This article is the fourth in a series on how to detect the traps and uncover the secrets the seller may be hiding from you.

Trap 13. Boosting Sales by Feeding the Till:

One of the immutable laws of business is that nobody overstates their income in a tax return.

I must admit I do rely on it being true, even though I know of one occasion where a devious seller fed the till from his own pockets to boost his sales.

That alone is not unique, but he followed through by showing the boosted sales in his tax return. He figured that the extra tax he paid would be more than covered by the higher price he got when he sold the business.

Its unusual for a vendor to be foolish enough to show one sales or takings figure on the tax return and another, higher figure on the figures presented to you. The explanation of course being that the difference is undeclared cash they have pocketed.

Anybody who does this runs the risk that you are from the IRS or whatever your tax office is called.

What is more likely is that as soon as they think they can trust you they pull you aside and whisper that they always take $100 a day out of the till and use it to “feed the family”.

This is exactly what happened when I revisited the GRB Shop. He said, “All retailers do it and you will too. It’s one of the few perks you get for working the crazy hours” and showed me a bundle of cash.

$100 a day in a 6 to 7 day retail business is about $30,000 a year you can add to the bottom line, and it certainly explained the high price they were asking. That is, if it’s true!

So, can you prove it one way or the other? The answer is, you can never be sure. You could try matching the till tapes to the bankings. This is very laborious however and assumes that all sales go through the till – and that there is a till and that the tapes have been kept.

There is a way in which you can get an indication of whether it is true or not but it is beyond the scope of this article to explain it in detail here. It requires the calculation of the Gross Profit to Sales % and its comparison with the industry average

But I don’t think you should try to prove it! It should be up to the seller! You should say something like “Look, you’ve given me these audited figures and now you are saying they are wrong? Unless you can prove that to me I am going to stick to what you first told me”.

Trap 14. Boosting Sales by Selling to Friends:

A clever client of mine told me that when he said this to the owner of a small (all cash) corner store the owner said, “Spend a week behind the counter and run the shop yourself before you sign up for it. You’ll see”.

My client did so and, yes, business was brisk. The friendly locals seem to come in just about every day to buy something. Unbeknown to everybody however my client quietly marked each item with a felt pen before he handed it over. Next morning they had mysteriously reappeared on the shelves.

The owner had his cronies spend up big, then met them around the corner where he bought everything back again and put them back on the shelves late at night.

Trap 15. Not Knowing the Sales Figures are Based on Bankings:

Note that in small retail businesses like this it is very common for accountants to get the sales figures from the bankings, not the till tapes. This leaves it wide open for the owner to put whatever they like as the sales figures, and this is generally accepted by the accountants. So much for the audited figures!

The message of this article is that if you encounter situations like these where you have some doubts about the figures but you want to proceed with the deal, there is one effective thing you can do. Hold back a % (say 25%) of the purchase price for (say) three months so you can be satisfied the figures are correct. If the owner agrees, there is a good chance everything is above board.

This article was written by Brian K Fitzgibbon CPA.

Brian is an experienced accountant and small business consultant. He runs his own business, lectures extensively on small business topics and has checked out and valued many hundreds of small businesses for buyers.

Brian is also the author of the highly acclaimed and invaluable
"How To Value A Business And Buy It Without Fear"
A do-it-yourself guide for first-time and experienced buyers alike.

To download a FREE Chapter from Brian's book please follow this link: "HowToValueBusiness.com"

July 27th, 2009 | Tags: accountants valuation, business valuations, buying a business, buying a dud business, checking out a business, checking the figures, dangers of business valuations, disclosure rules on buying a business, diy business valuations, due diligence on a small business, how to buy a business, how to check a lease, how to value a business, tips on buying a business, traps to avoid in buying a business, undeclared cash out of the till, valuing franchises | Category: articles | Subscribe to comments | Leave a comment | Trackback URL  |