As a Real Estate Broker, with years of experience in the field of Business Sales, Mergers and Acquisitions, I’ve certainly seen my fair share of Problematic Escrows.
Whether it’s Buyer/Seller disagreements, general disputes over assets, etc. – or, simply a misunderstanding that could have easily been resolved before matters escalate – there’s no question that the #1 Problem we encounter with would-be Buyers is how to accurately determine the true value of a business prior to Escrow, given these obvious initial road blocks:
- Sellers Hide Earings! YES, believe it or not – most small Sellers intentionally hide their true earnings – both in reporting to the IRS, as well as in their internal profit and loss statements. Why, you ask? Simply because they want to hold onto every dollar earned, and will go to great lengths to avoid paying any taxes at all, if they can get away with it! After all, let’s be honest: The #1 Reason people go into business for themselves is to have financial freedom! And “freedom” from reporting your true earnings is very, very common with small Sellers!
- Sellers Are Slow To Report True Earnings! When we take a business listing at BIZ Builder.Com, the very first thing we ask our Sellers to do is complete a standard California Association of Realtors “Business Disclosure Statement”, which – among other things, is designed to provide Buyers with a general “snapshot” of a business’ profitability. The problem we run into [more often than not] is that Sellers consider this an inconvenience – and usually don’t take this task very seriously. Unfortunately [for our Buyers] – we cannot complete this form on behalf of the Sellers we represent, so – we often find this to be a “log jam” when it comes to providing our Buyers with accurate financial information.
- Sellers Unintentionally Provide Financial Statements That Are Inaccurate! When we DO receive financials, they are usually NOT adjusted to reflect actual earnings – and usually DO reflect expenses that the Seller has taken out of their business for personal benefit. These types of expenses need to be “added back” onto the Financial Statements for Buyers to have a clear, accurate picture of the actual profits of the business.
Our challenge – as licensed Real Estate Professionals, is to make absolutely certain that our Buyers receive ACCURATE FINANCIAL INFORMATION from Sellers – given the 3 major problems we usually encounter as indicated above. How then, can we best help our Buyers to sufficiently overcome this problem? The answer is as simple as 1,2 3!
- FIRST: Consider hiring a qualified Business Valuation Specialist. To see the “real numbers”, you need to consider hiring a specialist who’s use to “uncovering” and “pulling out” hidden expenses that are actually income! For instance, if the Seller is deducting their child’s dance lessons from their general business expenses, this is an obvious attempt on the Seller’s part to reduce their reported earnings and avoid paying taxes – when, in truth, they are not at all related to actual business expenses. In our industry, we call this “ad-backs”, because these expenses need to be “added back” to the financial statement [thus reducing the over-all expenses and showing a more true picture of profitability].We can recommend several qualified Business Valuation Specialists – with fees ranging from $2,500 – $10,000, depending on the degree of study and tasks assigned by the Buyer. Please call our Sales Team at 1-800-727-2100, Ext. 202 – for further details.
- SECOND: Consider hiring your current CPA. Your current CPA is a great resource for helping you determine the true value of any business you’re considering to purchase. Our experience over the years is that often times – your own CPA is in the very best position to assist you, since they are also keenly aware of your own personal goals and objectives.
- THIRD: Consider extending the period of time to conduct “Due Diligence”. California Law stipulates that all Buyers entering a Valid Escrow must be given a minimum of 17 days to perform what’s called “Due Diligence” matters, which include – among other things, verifying Seller-Provided Financial Statements. The problem – as we’ve already discussed, is getting to the bottom of the Seller’s TRUE FINANCIALS! For this reason – we strongly recommend having your Broker extend the normal 17 day period to a minimum of 30 days, and – in certain circumstances, even longer. BUYERS MUST HAVE AMPLE TIME TO REVIEW SELLER FINANCIALS – AND THERE SHOULD NEVER BE ADDED PRESSURE TO ACCOMPLISH THIS GOAL!
SUMMARY AND RECOMMENDATION:
Since Sellers rarely provide full and complete Financial Statements to would-be Buyers, always remember that until an offer is actually accepted by the Seller, there’s little chance of ever discovering the true value of a business opportunity! For this reason – we highly recommend that serious Buyers simply:
- Enter Into Escrow “subject to” Buyer’s ability to perform a thorough and complete review/analysis of Seller’s Financial Statements, which may include [among other things] – a comprehensive review of Seller’s Financial Statements / Tax Returns by Buyer’s preferred Financial Consultant/s. Simply stated, you will never know the “true value” of a business until AFTER you enter into Escrow!
- Hire a Competent Professional to assist you in determining the businesses “true value”! If, after your review, it’s determined that the business does not meet your minimum standards, simply cancel the Escrow, altogether. Otherwise – you can move forward and close the transaction, knowing that you’ve confirmed all claims asserted by the Seller with 100% confidence.
Remember, when you enter Escrow to purchase the home of your dreams – a bank will immediately order an Appraisal to determine the “true value” of the home you want to purchase [so that they can verify sufficient equity to support your loan terms]. Similarly, on business purchases – the bank [who may also be the Seller or the Buyer] needs to determine the “true value” of the business prior to funding the loan. In order to determine “true value” – YOU MUST FIRST ENTER INTO A VALID ESCROW!
While there are always cases that may differ from the scenario discussed, by-in-large the greatest single “road block” preventing Buyers from finding the perfect business can easily be solved as soon as they are presented with an accurate picture of the Seller’s true financial position. Since Business Brokers representing Sellers are only authorized to present what information is collected directly from the Seller, a Buyer’s “best bet” to gain true and completely accurate information can only be had AFTER ENTERING A VALID ESCROW – AT WHICH TIME THE SELLER MUST PRESENT ALL REQUESTED FINANCIAL INFORMATION [INCLUDING TAX RETURNS, FINANCIAL STATEMENTS, ETC.] AS STIPULATED IN THE AGREEMENT, OR RISK JEOPARDISING A SUCCESSFUL CLOSING OF THEIR BUSINESS, ALTOGETHER.
For further details, please don’t hesitate to call us anytime! We’ll do our very best to answer all of your questions, and help you to avoid some of the most common mistakes Buyers often make when contemplating a business purchase.