How can I protect myself from a dishonest seller?

June 06, 2024

by a searcher from Yeshiva University - Sy Syms School of Business in Boca Raton, FL, USA

So I bought a small business. O snap! That's kinda how I feel.

Here's the short version of the story - I bought a Budget Blinds territory resale. It didn't cost a lot and there is so much potential in this territory. So although the business itself is not at all what I envisioned acquiring (in just about all aspects), I went ahead with it. I'm not specifically asking for constructive criticism on this part, but I'm more than happy to hear.

During due diligence, the seller and the franchisor rep basically told me I can get the p&l and tax returns from the seller, but they "can't" give me anything from within the proprietary software of the business bc it's all franchisor related stuff. I accepted it bc I didn't know any better.

The whole time, it bothered me just a bit, but I figured they probably do this for all their resales. Additionally, I have a lot of confidence in the franchise system since it's so big and old.

Anyhow, now the good stuff. The seller took money from customers for products but never paid vendors/ordered the products. So these customers are calling the business phone now upset that they've waited for so long, and it's the first time I'm hearing about it.

Also, the day before closing, the seller told me there was 2 customers they did this to. The day of closing, post closing, they said there's another 3 they forgot to tell me about. But in reality, it's 13 and counting.

My path forward is clear - I want to keep my name/brand good, so I'll handle it. Corporate is hanging me out to dry. (If you have any advice on how to gain leverage over a behemoth, that'd also be appreciated)

But looking backward - what type of due diligence could I have done to prevent this situation? Is escrow the only solution for this type of thing (we did have a small escrow account, which has already been paid out to me)?

Thanks!

Reply by a professional
from University of Southern California in North Palm Beach, FL, USA

Here's another idea for anyone reading this: before buying a business tell the seller you need answers in writing and tell the seller (when you ask the questions) that you'll be attaching the seller's representations to the purchase contract. This is a good way to repel people intending to cheat you. On the other hand, you can still be cheated by people wanting to do it, and they have your money and you have their perhaps lousy business with little practical recourse.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I am so sorry to hear this happened to you. I am not sure if you did a QofE or had an accountant help you with any due diligence. In the process of understanding how they were getting paid I think the question of deposits would have come up. They also should have been showing deposits on the balance sheet. If they did not tell you about that when you were asking questions about how they get paid, then that was wrong of them. At the end of the day it is very important to see all records and systems before closing and to verify all vendors are paid. A good review of the balance sheet, A/R reports, billing records, deposits, orders, etc. should have given you this. They should have given you access to the system or reports to review in advance. Again, I am sorry this happened to you. I highly recommend everyone at least consult with their attorney and a CPA about what they need to do if not have a QofE done. It is also why it is important to have an attorney that understands M&A so they can help you watch out for these items.

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