Business buyers can fall victim to various tricks and schemes when dealing with business sellers.
Here are some common tactics used by unscrupulous sellers to deceive potential buyers, plus some ways business buyers counteract tricky sellers. (Some of these topics may seem repetitive; look for what differs.)
Experienced dealmaker, Nic Cooper, who is looking for another business acquisition says: “I think the ending recommendations are the meat of this information. I’m going to ask those questions before I involve costly legal and accounting help.”
- Believing the Company for Sale is the Best Opportunity: It probably isn’t. Keep reading for how to access all the businesses for sale, especially on the hidden market.
- Unrealistic Projections: Sellers might provide overly optimistic revenue or profit projections to make the business seem more attractive. Likewise, beware of faulty cash flow projections and working capital representations. Buyers should critically assess the feasibility of these projections.
- Incomplete Documentation: Incomplete or missing documentation can hinder due diligence. Buyers should insist on obtaining all necessary records and documents before proceeding with a purchase.
- Misrepresentation of Financials: Sellers may manipulate financial documents, such as profit and loss statements, balance sheets, or tax returns, to make the business appear more profitable than it is. Buyers should conduct thorough due diligence and, if concerned, hire an accountant or financial expert to review the financial records.
- Incomplete or misleading documentation: Sellers might provide incomplete or altered documentation related to the business’ operations, assets, or financials. Buyers should request and thoroughly review all relevant records.
- Incomplete Disclosures: Sellers may provide incomplete or vague information, making it difficult for buyers to assess the true value and risks of the business.
- Incomplete Intellectual Property Disclosure: Failure to disclose the status and ownership of intellectual property, such as trademarks, patents, or copyrights, can lead to legal disputes. Buyers should ensure the seller has the legal right to transfer these assets.
- Misunderstanding Cyberrisk and Security. Verify “Everything’s fine!” Faulty cyber risk assessment is one of the most dangerous risks.
- Misleading or Forged Documents: Buyers should carefully review all documents and contracts to ensure they are genuine and accurate. Be cautious of forged or misleading paperwork.
- Sellers Asking for Large Deposits: Be cautious if the seller requests a significant deposit upfront. This may indicate a lack of confidence in the deal’s legitimacy.
- Accepting Unverified Financial Records: Buyers may be provided with financial documents that are not independently audited or verified. Were they prepared by competent accounting personnel? Always insist on reviewing financial statements to ensure accuracy.
- Sudden Changes in Price: Sellers may pressure buyers into quick decisions by claiming they have other interested parties or by demanding a higher price or offering a price reduction. This can lead to rushed decisions without proper due diligence and valuation.
- Bait-and-Switch: A seller may advertise a business for sale with certain features or assets, only to change the terms or conditions once the buyer is committed. Always have a well-drafted letter of intent or purchase agreement to prevent such changes. (Take careful notes about he said / she said.)
- Hidden Ownership or Partnership Disputes: Sellers may not disclose internal ownership disputes or conflicts with partners that could affect the business’ stability. Investigate the legal structure and ownership agreements. Buyers should inquire about any ongoing disputes or issues among the seller’s partners or shareholders.
- Asset Stripping: Dishonest sellers might transfer valuable assets out of the business before the sale, leaving the buyer with a less valuable entity. Verify the integrity of the business’ assets and their ownership.
- Delayed Transfer of Key Information: Dishonest sellers may delay providing crucial information until the last minute, pressuring buyers to make quick decisions without conducting thorough due diligence.
- Unrecorded Cash Transactions: Sellers may not accurately report cash transactions, such as skimming, under-the-table income, or off-the-books deals. This can distort the business’ true financial picture.
- Sweetheart business dealings: Sweetheart deals tend to be secretive and controversial. They can be unethical and disadvantage those not privy to it. Some sellers showcase these “sweet” dealings to lure unsuspecting buyers. Carefully scrutinize the seller’s customers and suppliers for the kinds of too-sweet-to-be-lasting relationships that won’t continue when the company changes hands.
- Unrealistic Valuations: Sellers may overvalue their business, leading buyers to pay more than it’s worth. It’s essential for buyers to conduct thorough financial analysis and obtain a competent independent valuation.
- Blue Sky Vs. Goodwill: This, from an American Business Group/Mid-Market Merger & Acquisition Letter, which I saw several years ago, concerns goodwill: “Brokers confuse goodwill with blue sky. Goodwill is supported by the historical earning capacity of the company. On the other hand, blue sky is projected future earnings based upon assumptions that are not supported by the company’s historical performance. Buyers will seldom pay for blue sky, but they will buy goodwill. The difference between the two is cash flow.” That’s why so many people (and their advisors) who buy and sell small businesses hone their skills with How to Buy the Right Business the Right Way: Dos, Don’ts & Profit Strategies.
- Beware of Goodwill: Especially if its basis is the owner’s personal relationship with the company’s C.E.L.B.S.™ (An acronym I coined.) Customers. Employees. Landlord. Bank. Suppliers. To what degree can you reasonably expect to match or surpass the quality of the seller’s business relationships with them?
- Under- or Over-Valuing the Non-Financial Factors: Some of them are C.E.L.B.S.
- Overvaluing Assets: Some sellers may overstate the value of the business’ assets, such as equipment, inventory, or real estate. Buyers should have these assets independently and competently appraised to verify their value.
- Overstating Intellectual Property Rights: Sellers may exaggerate the value of their intellectual property, patents, or trademarks. Buyers should conduct due diligence to confirm the validity and value of these assets.
- Manipulating Inventory: Sellers can overstate the value or quantity of inventory to inflate the business’ worth. Buyers should physically inspect inventory and have it professionally appraised.
- Outdated or Inaccurate Inventory: Sellers may overstate the value of inventory or provide inaccurate information about inventory turnover. Physical inventory checks can help verify the accuracy of reported figures.
- Phantom Revenue: Some sellers may record fictitious sales or manipulate revenue figures to inflate the business’ value. Buyers should validate revenue through bank statements, tax records, and customer invoices.
- Hiding Liabilities: Sellers might not fully disclose risks, outstanding debts, loans, or legal obligations that could become the responsibility of the buyer after the sale. Due diligence should include a careful examination of liabilities, especially potential liabilities
- False Financial Information: Sellers may provide inaccurate or fabricated financial statements, inflating the business’ profitability and concealing liabilities. Buyers should conduct thorough due diligence and verify financial documents.
- Inflated Financial Statements: Sellers may exaggerate the financial health of the business by inflating revenue, understating expenses, or misrepresenting profits. Buyers should carefully review financial documents and consider hiring a financial expert to conduct a thorough review.
- Unrecorded Liabilities: Sellers may conceal or downplay outstanding debts, pending lawsuits, or other liabilities that could negatively impact the business’ value or future prospects. Due diligence should involve a comprehensive review of legal and financial records.
- Deferred Liabilities: Sellers may postpone paying bills or taxes, leaving buyers responsible for settling these debts. Buyers should request a complete list of outstanding liabilities.
- Unpaid Taxes and Wages: Ensure that all tax obligations, employee wages, and other liabilities are up to date and disclosed. Unpaid taxes or wage claims can become the buyer’s responsibility.
- Environmental Issues: Concealing environmental liabilities or regulatory violations can lead to significant costs for buyers. Environmental assessments should be part of due diligence.
- Unreported Income: Some sellers may not disclose cash transactions or underreport income to lower tax liabilities. Skimming is prevalent in some fields. When recasting profit and budgeting cash flow, it’s not a best practice to include the seller’s admission of income not reported to revenue or income taxing authorities. The seller effectively received part of his price in the form of taxes not paid. He lied to the government. Would he lie to you? This can affect the true value of the business and its profitability.
- Misleading Projections: Sellers might present overly optimistic business projections to entice buyers. It’s essential to critically assess the validity of these projections and conduct independent market research.
- Misrepresenting Market Demand: Sellers may exaggerate market demand (i.e., potential) for their products or services. Buyers should conduct independent market research to confirm the demand.
- Fraudulent marketing materials: Some sellers use deceptive marketing materials, such as misleading photos, information, or customer reviews, to create a more positive impression of the business. This is why it is useful for potential buyers to interview customers.
- Employee Deception: Sellers can mislead buyers about the loyalty and stability of the workforce. It’s crucial to verify employee compensation against market rates, employment contracts, HR policies, and retention/turnover. Savvy potential buyers interview employees.
- Contractual Traps: Sellers may include onerous or hidden contract terms that could prove detrimental to the buyer after the sale. Carefully review all contracts, agreements, and leases.
- Fictitious Customer or Supplier Contracts: Some sellers create fake contracts with customers or suppliers to artificially inflate the business’ value. Buyers should independently verify the authenticity of contracts.
- Customer and Supplier Contracts: Sellers may misrepresent the strength and terms of customer and supplier contracts. Buyers should review these contracts and verify the accuracy of the information provided.
- Pending Contracts and Orders: Concealing the loss of significant contracts, orders, or clients can be used to make the business appear more valuable. Buyers should request a list of current and pending contracts and then perform due diligence on them.
- Incomplete or Falsified Documentation: Insist on complete and authentic documentation for all aspects of the sale, including financial records, contracts, and legal documents. Be wary of sellers who are reluctant to provide these documents.
- Undisclosed Supplier or Customer Relationships: Sellers may have undisclosed business relationships that are critical to the operation of the business. Buyers should identify and assess these relationships during due diligence.
- Customer and supplier relationships: Sellers may not fully disclose the nature of their relationships with key customers or suppliers, and these relationships could be at risk or unstable.
- Fake Customers or Revenue: Some sellers may create fake customers or inflate sales figures to make the business appear more profitable. Verify the authenticity of customer relationships and revenue sources.
- Skewed Customer Feedback: Be cautious of businesses that provide selective or manipulated customer reviews and feedback to create a more positive image. Seek feedback from independent sources.
- Hidden Legal Issues: Concealing legal disputes, pending lawsuits, or regulatory violations can leave buyers with unexpected legal and financial burdens. A comprehensive legal review is essential.
- Withholding Critical Information: Sellers might not disclose essential information, such as pending legal issues, regulatory compliance problems, or the existence of a strong competitor about to enter the market. Conduct thorough legal due diligence.
- Undisclosed Competition: Sellers may not reveal the existence of new or growing competition that could negatively impact the business. Buyers should research the industry thoroughly and assess the competitive landscape.
- Undisclosed Marketplace Challenges: Some sellers may omit information about marketplace challenges that could impact the business’ prospects. Conduct a thorough market analysis to identify potential threats.
- Undisclosed Competitive Threats: Sellers may not reveal competitive threats or other factors that could adversely affect the business’ prospects. Conduct a competitive analysis and industry research to uncover potential risks.
- Undisclosed Degree of Competition: Some sellers may not reveal the true extent of competition in the market or downplay the impact it may have on the business’ future.
- Undisclosed Regulatory Violations: Sellers might not reveal past or ongoing regulatory violations, compliance issues, or pending risks or audits. Consult with industry regulators and conduct regulatory due diligence.
- Hidden Operational Issues: Sellers may not disclose operational problems, such as supply chain issues, employee disputes, or customer complaints. Buyers should thoroughly investigate the business’ operations and seek input from current employees.
- Concealed Equipment or Property Issues: Sellers may not disclose equipment or property problems, such as maintenance issues or leases with unfavorable terms. A thorough inspection can help uncover such problems.
- Employee and Contractor Misclassification: Sellers may classify employees or contractors incorrectly to reduce labor costs. This can lead to legal and financial challenges. Review employment contracts and legal compliance carefully.
- Unreported employee issues: Sellers may not disclose labor disputes, ongoing employee conflicts, or issues that could lead to legal or financial problems.
- Employee and Key Personnel Issues: Sellers might not disclose employee morale issues, high turnover, or the impending departure of key employees. This can impact the continuity and success of the business.
- Seller Financing Pitfalls: When sellers offer financing for the purchase, they may impose onerous terms, variable interest rates, or hidden fees. Buyers should carefully review and negotiate the terms of seller financing.
- Non-Compete Agreements with Strings Attached: Sellers may include non-compete clauses in the contract with unreasonable restrictions that hinder the buyer’s ability to operate in the same industry. Ensure that any non-compete agreement is reasonable and enforceable.
- Violation of Non-compete Agreements: Sellers may not disclose their intention to start a competing business after the sale, potentially harming the buyer’s investment.
- Escrow or Earn-Out Schemes: Sellers might propose deals with an earn-out or escrow arrangement that’s heavily weighted in their favor. This can be a way to ensure they receive more money than the business is actually worth or making it challenging for buyers to access funds they’re entitled to. Buyers should carefully scrutinize these arrangements and consider the risks.
- Earn-Out Agreements with Ambiguous Terms: Sellers may propose earn-out agreements with unclear or ambiguous terms, making it difficult for buyers to achieve the expected financial goals.
- Pressure Tactics: Some sellers use high-pressure sales and manipulative tactics, such as claiming that the opportunity is limited, to rush buyers into making quick decisions without adequate due diligence. It’s important for buyers to take their time and not succumb to pressure.
- False Promises of Future Growth: Sellers may make grandiose claims about the business’ growth potential, which may not be realistic. Buyers should carefully evaluate the market and the potential for growth before making a purchase.
- Inadequate Transition Assistance: Sellers may promise to help with the transition but provide minimal support after the sale. Ensure the terms of the transition assistance are clearly defined in the purchase agreement.
- Lack of Training or Transition Support: Some sellers promise training and transition support but fail to deliver. Clarify and document all post-sale commitments in the purchase agreement.
- Underestimating the Quantity and Variety of Businesses for Sale: The hidden market of businesses for sale is where up to 80% of the mature, profitable, and fairly-priced small and midsize businesses are quietly for sale by-owner. Few of these owners advertise their business for sale. Some of these winners are not yet on the market, but they and other sellers want to safely meet qualified buyers. Few of these owners will admit they are for sale to buyers they don’t know. This is where Ted Leverette, The Business Buyer Advocate ®, can magnify your opportunity. Accessing the hidden market can save you valuable time, and you can avoid buyer competition because these businesses are not available to the general public.
- Why settle for some of the businesses for sale if you can access all of them? The hidden market is where to find unadvertised businesses for sale by-owner (or could be for sale to buyers who properly approach and interact with owners) . . . with less or no competition from other buyers. Here’s how to avoid or beat buyer competition: How to Prepare Yourself and Find the Right Business to Buy: (You Can’t Buy It If You Can’t Find It)
To protect themselves from these common tricks, business buyers should:
- Conduct thorough due diligence: Carefully review financial records, contracts, and legal documents to ensure their accuracy and completeness. Don’t forget non-financial due diligence.
- Seek professional advice: Consult with business buying strategists, attorneys, accountants, business valuation experts, and the best business brokers who can help evaluate the deal and identify potential issues.
- Use escrow accounts: Secure a portion of the purchase price in an escrow account to cover any undisclosed liabilities or disputes that may arise after the sale.
- Negotiate clear and detailed contracts: Ensure that all terms, conditions, and representations are clearly outlined in letters of intent, purchase agreements, and related communications.
- Be patient and skeptical: Avoid rushing into a deal and be cautious of deals that seem too good to be true.
Here’s a question to ask everyone you interview . . .
- and then again ask sellers before your legal counsel begins drafting purchase documents:
“Is there any information that you have not disclosed to me that might have an adverse bearing on the viability or the value of the business for sale?”
- Too many business buyers don’t pose that question to everyone. Everyone.
- Worse, too many buyers let people get away with a non-definitive answer.
- Buyers correctly asking that question at the right time will see a road map for further inquiry. Not asking that question (and then verifying the response) is why so many dumb deals occur.
By taking these precautions, business buyers can reduce their risk of falling victim to deceptive tactics used by unscrupulous sellers, the knowledge of which can help buyers make more informed investment decisions.
Need help right now?
Schedule an hour of coaching with Ted Leverette, The Original Business Buyer Advocate ®
Preview my books:
21st Century Entrepreneur Ideas for Kids and Aspirational Adults (Complimentary)
How to Get ALL the Money You Want For Your Business Without Stealing It (USA and Canadian versions.)