Uncovered Financial Discrepancies Post-Diligence in First Business Purchase
January 15, 2024
by a searcher from Louisiana Tech University - College of Business in Houston, TX, USA
Hi SF Community
I'm reaching out for advice on a situation I've encountered in my journey of acquiring a business.
Last year, I embarked on a search and eventually settled on a prospect. The business, a DBA under a corporation, has been operational for four years. It has annual sales of approximately $1.7 million and an SDE of $250k. The purchase price was set at $500k. The sellers are eager to shift industries, The sellers had another DBA under the same corporation.
Due to the deal size, I opted to conduct due diligence independently. The financials were marred by poor accounting, had substantial cash transactions which is common in this industry and were challenging to decipher. The sellers were both operators and attributed the bad state of their books to lack of sophistication about book keeping and poor advice from a former accountant. After an arduous process, I believed I had a good grasp of the business's financial health and proceeded to secure an SBA loan and signed the loan commitment letter and paid the necessary fees, including an escrow fee to the seller's attorney. We are proceeding to loan closing in a couple of weeks.
However, in a recent review of the financial and bank statements, I uncovered a critical oversight: the sellers had been inflating revenues by moving funds from their other business and covering its expenses through these transfers. This discovery, made within the last 24 hours, has yet been shared with the sellers or the bank. I fully intend to inform the bank and the sellers as soon as possible. I'm seeking community's wisdom and experience in navigating this situation:
How should I approach the sellers and the bank with this discovery?
Are there specific legal or financial repercussions I should be prepared for?
Any advice on protecting my interests and possibly renegotiating or withdrawing from the deal?
I greatly appreciate any insights or experiences you can share.
Thank you for your time and support.
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA
You need to approach the seller and let them know what you discovered and address it with them directly. Find out what is going on and if there is some sort of explanation. If there is no explanation, you need to quickly figure out the impact to the cash flow and financial situation. Any LOI or contract you have signed should have out clauses if you find something out during due diligence of if there is a material change in financial condition. You can also try to renegotiate the contract. This is a good time to get your attorney involved.
Once you know you have a problem with the seller for sure, then I would inform the lender once you know how you are going to handle the deal. If you plan to change the structure, you can bring the revised structure to the lender. If it is a lower purchase price, they should not have an issue with approving it. If you decide to walk from the deal, then you need to tell the lender as soon as you are sure that is going to be the outcome. If you need time to negotiate you can tell the lender you are holding off while you figure something out with the seller to buy yourself some time.
Keep in mind any money already spent from your deposit on third party costs with the lender is definitely going to be gone at this point. Also, some lenders in their commitment letters state the commitment fee is earned even if you do not move forward with the deal. Hopefully if you have a lender that wants to do future deals with you they would still refund you or credit back any fee not used for third party expenses understanding the deal blew up from no fault of your own.
Hopefully this helps. Please message me if you have any additional questions. Good luck and sorry to hear you are in this situation.
in Boca Raton, FL, USA
Do you have any sense of the revised SDE if you can even figure it out? If the SDE still makes sense to proceed, price, financing, and deal terms will have to be revised. BUT, to me the BIG issue here is what did the seller really know and what if anything was hidden. If this was covert and purposely not disclosed, don't walk from the deal....RUN. You may have to go after the sellers for your out-of-pocket SBA lender fees or the lender may)...hopefully you don't have to go down that road and the sellers should be aware of this potential consequence for them if all of this was anything other than an honest oversight....(probably not is my guess).