This is a true story of one of my due diligence assignments regarding a dry cleaner for sale in West Los Angeles, California.
George made an offer with the help of the listing broker on this West LA dry cleaner. The offer was made and accepted before I was brought into the picture. The listing agent explained that after escrow was open, the due diligence period begins, and that is when a CPA would start the due diligence. The offer had a due diligence period that started after the offer was signed by the seller. It also had a $30,000 deposit with a liquidated damage clause. Liquidated damages actually means the seller and broker can keep the deposit, if the buyer backs out of closing the purchase of the deal. The liquidated damage clause is supposed to kick in after the contingencies have been removed, which would be after the due diligence period has ended.
To repeat myself, the buyer was told by the broker that due diligence is done after the opening of escrow. This on the surface makes sense. I was hired after the opening of escrow. I never saw the purchase agreement or escrow instructions until weeks later when the problems started.
My due diligence showed that all of the employees were being paid as independent contractors on 1099 forms and not as W-2 employees. The IRS would never go along with the staff not being employees. If or should I say when they audit this company, they would charge the business owner with the payroll taxes of the employer's portion and the employee's portions, as well as penalties and interest on the unpaid taxes. State Workers Compensation Fund would also be looking for their money. Trying to classify employees as Independent Contractors can save the employees 15% deductions off their paychecks and the employers 20% in payroll taxes, including workers compensation insurance. This illegal act reduces the profit substantially when the payroll is $150,000.
The other things discovered were:
A. Rent on the tax return were way off from the reported rent numbers by the seller. We are talking $100,000 difference on the rent.
B. The tax return showed $300,000 more gross income then the broker reported to the buyer on the business summary. Whoever reports more income to the IRS then they took in? I never did figure this one out.
C. The other important fact, not presented in the business summary report was that the second location was an agency; not a full dry cleaning plant. An agency is just a store front for collecting and delivering finished work. No other activity takes place at an agency. This substantially changes the profit and value of the business.
As a result of our discovery, the buyer, told escrow to cancel the contract and return his security deposit. Escrow then cancelled escrow and gave the full $30,000 deposit to the seller and broker. That was a shock to both the buyer and myself. This of course raised a lot of questions by me. I then asked for and received the purchase contract and escrow instructions from the buyer.
What I found was that the broker, immediately after having the purchase contract signed by both parties opened escrow. Instead of giving escrow the purchase contract, which has a due diligence period; the broker gave the escrow different instructions, not related to the contract. The escrow instructions said. "Due diligence has been completed."¯ That translates into, if the buyer didn't go through with the purchase, or any reason, the deposit was forfeited and given to the seller and broker.
The buyer assumed, as anyone would, that the contract and escrow were identical. English is the buyers second language so he did not understand what he was reading; consequently the buyer listened to and relied on what the broker told him.
Lessons to be learned:
1. Read everything you sign. If you do not understand what you are reading do not sign it until you do.
2. Get advice from an experienced CPA, in these matters or an attorney; not necessarily the listing broker/agent or business owner selling the business.
3. Assume nothing, and remember. "If it is not written it is not true."
About The Author: Willard Michlin, CPA (106752) offers business buyers Due Diligence Services (Second Opinion, Offer Assistance, Final Due Diligence) when they are thinking of making an offer on a business or in the process of investigating a business purchase. He has written numerous articles on the due diligence process and can be reached direct at 805-428-2063 for more information and an appointment.
|Helpful Resources To Assist In Selling And Buying California Businesses|
|Lee Petsas, Business Broker - Southern California Area
Lee Petsas has been selling businesses with UBI Business Brokers in Southern CA since 1981. In 1999 he became the Owner and Broker for UBI. He has been approved multiple times by Courts as an Expert Witness in the area of Business Valuations.
|Mani Singh CBB, M&AMI, Business Broker, Southern California
I have successfully represented clients sell & acquire multitude of businesses ranging from Gas Stations, Liquor Stores, Markets, Super Markets, Smoke Shops, Postal Stores, Restaurants, General Retail, Auto and Construction related. Phone me for assistance with selling or buying at 951-296-7646 Cell
|William Park, Business Broker - Southern California
Highest Volume Broker in California, Simply Check our HUNDREDS of Listings! Over 25 Associates, Speaking Dozen Languages, Helping Buyers and Sellers of Small Business since 1982, Centrally Located between Los Angeles and Orange Counties, while Riverside & San Bernardino Counties are Very Accessible.
|Peter Siegel, MBA, BizBen Founder, ProBuy, ProSell Programs
Founder & President Of BizBen.com (since 1994). I am the Lead Facilitator for both the ProSell & ProBuy Programs. I consult daily with business buyers, business owner/sellers, brokers/agents daily about buying and selling California small to mid-sized businesses. Call 925-785-3118.
|Michael Davidson, Business Broker - Southern California
Los Angeles Business Broker providing M&A quality services for Small Business Owners. We leverage our technology and expertise to Simplify & Expedite the Business Sales Process. Matching the right buyer with the right business is how we define success.
|Joe Ranieri, Business Broker: Orange, LA County Areas
Having owned retail/restaurant businesses for over 20 years, my interest turned to selling businesses rather than owning them. I specialize in LA & Orange County restaurants, fast food independents and chains, bars, & liquor stores. Call 714-292-5448 Cell/Text.
|Jack Oh, Business Broker: LA, Orange Counties
Business broker and real estate services in the Los Angeles and Orange County areas. 10 years experience with great negotiating skills. To sell a business or buy a business in the LA or Orange County Areas phone Jack and his team at 562-787-4989.
|Chris Seaman, Business Broker: Southern California
Founded in 1994, First Choice Business Brokers has accelerated to become one of the most successful Business Sales Organizations in the world. Our team of agents have gone through extensive training to become experts in the field of business brokerage. Call Chris at 858-578-4111 for more info.
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