First and foremost, I am not an attorney and cannot give legal advice. Second, I am not affiliated with the IRS or any law enforcement agency. Third, I am going to recite “stories” I have heard from “other” brokers during the last 24 years.
Let’s go case by case. An owner of a trophy shop said he was earning $145,000 from his business, but the tax return said $98,000. To prove the missing $47,000, he walked over to a desk drawer and pulled out a stack of customer invoices that all said “cash sale.” The buyer ran an adding machine tape on the 14 inch high stack, and the total came within $700 of the correct difference. The buyer then went through an entire year’s deposit slips and bank statements and discovered that never once was any cash or checks deposited. Only credit card sales were shown. The buyer concluded that it was very probable that the invoices were legitimate and that the owner kept all cash and checks from the business as unreported income.
The next situation was where the owners of a pizza parlor claimed they were making more than $100,000 a year but their tax return showed $49,000. The buyer asked the owners to prove the missing sales figures. The husband went to his Point of Sale cash register and printed out a very, very long report. The report showed sales by day, by week, by month and for the year. Then he printed out a second report that showed “voided transactions.” The total of the voided transactions report was $56,000. So the tax return plus the voided transactions report totaled $105,000, and the buyer bought the business.
The next situation is absolutely the most unbelievable story I have ever heard in 23 years of being a business broker. Two men who owned a liquor store said they would not sell for less than $300,000 all cash. They guaranteed a minimum inventory of $50,000. Their tax return showed that they earned $55,000, but they claimed they were making $109,000. When asked to explain the difference of $104,000, they said that each of them withdrew $1,000 cash a week for a combined total of $104,000. But the broker and the buyer wanted “proof” of this. The owners then pulled out 16 years of over-sized multi-column accounting spreadsheets. The older years were clearly very, very old, and the more recent years looked cleaner.
But the next part of the story is the 8th wonder of the world. They had kept track of sales for the past 16 years, not by year, not by month, not by week, not by day but actually by “hour.” As unbelievable as this may sound, they could tell you how much product they sold between the hours of 2:00 p.m. and 3:00 p.m. March 26, 1987 or between the hours of 9:00 p.m. and 10:00 p.m. on a Friday night in 1991. When the buyer saw the extraordinary “accounting records” they had been maintaining, he wrote them a check for $300,000 without any further due diligence.
The next situation is not outrageous like the last one. A buyer wanted to buy a light manufacturing company. When he compared the tax return to what the owners claimed they had made from the business, the difference was $22,000. The buyer asked the owners to prove where the missing $22,000 could be found. They went to a file marked “confidential” and produced photocopies of checks that had been written to them personally during the year. These checks totaled the exact amount that was missing, and it was obvious that they were never deposited into the company checking account.
I could go on and on with other stories, but the old adage “buyer beware” certainly applies in all cases. There is a reason for “professional due diligence” using a CPA firm. You want to avoid making the mistake of your lifetime by believing something too good to be true. You need to obtain “unassailable proof” before taking the plunge, and when in doubt, run, don’t walk from any situation where the owner has to work too hard to “convince” you of what he is making that cannot be supported by tax records validated with the IRS.
After helping sellers and buyers for more than 20 years, I have found that honesty, integrity, full disclosure, patience and a willingness to consider various alternatives makes the probability of success for all parties very high.
Loren Marc Schmerler, CPC, APC is the former business advice columnist for Sam's Club. He has been a business broker since 1986 and works with business owners and business buyers in every state of the country. If you need assistance selling or buying a business anywhere in the United States, you can reach Loren at 404-550-1417, 24/7/365.
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