Buying an existing business can be a great opportunity if you know what to look for. When considering a business acquisition, you should always keep an eye out for any weaknesses or hidden issues that could lead to significant problems. In this article Adam Ferrari, CEO of Ferrari Energy focuses on six business red flags that you should never ignore when researching a potential business venture.
1. Cash Payments to Employees or Contractors
Cash payments are a notorious method for taking money out of a business without leaving a proper paper trail. If you see vendors, employees, or contractors receiving cash payments, investigate. Be wary of explanations or excuses that certain vendors just prefer cash payments. All payments should be made by check or card to ensure that there is a proper record of expenses and that money going out of the company is for legitimate expenses only.
2. Unclear Ongoing Expenses Not Clearly Connected to the Company
Look out for ongoing expenses for vague purposes such as "consulting" or "training." Embezzlement of company funds is often connected to fraudulent contracts or deals that do not have any connection to any real value conveyed to the company. If anything looks suspicious, look into what the alleged contracts are for and exactly who the recipient of payments from the company is. Also, request supporting documents and any evidence of tangible benefits received by the company.
3. Business and Personal Expenses Are Mixed Together
At best, using corporate checks and cards to pay for personal expenses is a huge bookkeeping problem, even if the funds are paid back to the company. At worst, employees or owners use company accounts as a personal checking account and the money never gets properly accounted for. This type of activity can create tax and valuation problems far into the future. At a minimum, you should request and receive receipts or other satisfactory documentation for questionable expenses.
4. Undisclosed Business Developments
You should always have a clear understanding of why someone is interested in selling a business. Ask direct questions about the local marketplace, including whether new competitors are entering the market or if any employees or previous owners of the company have left to open up competing firms in the recent past. It may be that the current owner is simply retiring, or it could be that they are jumping ship before new competition enters the scene, intent on taking current customers along.
5. Incomplete Tax Records
In addition to examining the company's financial books, you should thoroughly review tax records. This is important not only to verify internal accounting but also to be sure that the company has been properly paying all taxes it has been responsible for. If sales tax, employment taxes, or any other tax due has not been paid, the revenue agencies will look to you to collect unpaid taxes and fees. These assessments can easily close a business down and create a huge unplanned liability that you will be responsible for. When possible, request and obtain a tax clearance certificate from the relevant taxing authority.
6. Prior or Pending Litigation
Lawsuits are a part of doing business, and there are usually good explanations for why a company has been sued or sued others in the past. However, if you see excessive or unexplained litigation in a company's history or current status, request some assistance from a competent attorney to audit the company's litigation status. Litigation can indicate prior poor practices or increased risk of future legal exposure.
About Adam Ferrari
Adam Ferrari is the founder of the Denver-based mineral acquisitions company Ferrari Energy. He is a chemical engineer by degree and is an accomplished petroleum engineer by profession. He also has experience in the financial sector through his work at an investment banking firm. Under Adam Ferrari's leadership, his company has supported numerous charitable organizations including St. Jude Children's Hospital, Freedom Service Dogs, Denver Rescue Mission, Coats for Colorado, and Next Steps of Chicago.