In Bankruptcy Because of Seller Fraud in a Purchased Business
All too often we meet clients who moved down to Florida with hopes of being in business for themselves. The story is the same each time. Sadly, a bad business purchase can lead to the loss of life savings, retirement funds, and personal bankruptcy.
Meet “Bob” from Michigan. Bob worked in the corporate world for 35 years, accumulating a nice 401(k) Upon retirement he and his wife move to Wesley Chapel and buy a retail store from Shady Pete. Bob thought he was smart in asking for financial documents before he agreed to the purchase in the amount of $950,000. Shady Pete agreed to finance $700,000 of the price and Bob’s 401(k) was used for the rest. In the due diligence period, Bob ensured that there were no lawsuits against the store. He also verified the profit and loss statements by looking at Shady Pete’s paychecks to confirm the owner benefits were accurate.
Shortly after the purchase, all kinds of problems emerged. Turns out that much of the perishable inventory was due to expire. Vendors had not been paid in weeks, and Bob started receiving notices from the Florida Department of Revenue about unpaid payroll and sales tax. A former employee filed a lawsuit against the store. On another day, the Bob learned that much of the valuable inventory was actually on a consignment basis.
Upon further investigation, Bob learned from the employees that Shady Pete was a fraud and falsified the numbers to induce Bob to buy the store. The paychecks that he showed to Bob were never actually cashed. The store was probably only worth $200,000…and Bob’s hard earned 401(k) was gone. To add insult to injury, when Bob stopped paying Shady Pete on the seller financing promissory note, he was served with a lawsuit.
Does this scenario sound familiar? Fortunately, there are legal options for Bob. That’s what we are here for. We cannot go backwards and undo past decisions, but moving forward, Bob need not lose sleep over something that can be resolved through the courts.
Here are some common things that business sellers can do to defraud buyers. These are things that you might not think to investigate during the due diligence period, so be wary!
- If the seller is claiming personal income from the business, is he actually cashing his checks?
- Is the equipment used as collateral for the seller’s personally guaranteed loans?
- Which employees will stay, and which will leave? Are any disgruntled, and/or planning on becoming your competition after the sale? Is the seller signing a non-compete? Can he be trusted?
- What about the inventory? Is it close to expiration? Are there any government regulations that have changed which could affect your ability to sell it?
- Is any of the inventory on a consignment?
- Is the seller leasing back any property prior to the sale? Will he be leasing it below market value to his friends?
- Likewise, what about employee wages and bonuses…will the seller be giving away golden parachutes to his friends and family?
- Are there any lawsuits threatened against the business? Any labor law or worker’s compensation disputes? Has anyone been injured or hurt at the business?
- What about gift cards and gift certificates? A common tactic by an unscrupulous seller is to give away massive amounts of free stuff to his friends, family, and good customers before the closing.
If in doubt, do your homework first. An anxious seller (and greedy business broker) may push you to close quickly, which is always a red flag. Keep in mind that the above threats are not usually something that can be prevented by having a business law attorney handle the closing transaction. Even with iron-clad legal documents signed by the seller, you could still end up buying a “pig in a poke.”
Too late? You have legal options, and we can help. Contact us for a consultation.
