I was recently hired by an agent who had just acquired another agency. The buyer was upset. He said the seller had misrepresented the agency's revenues, liabilities, company relations and growth, among other things. He also said the seller claimed his agency was in trust. It was not.

Unfortunately, this situation is not unusual. Buyers often discover unpleasant surprises when the deal is done. Sometimes it goes the other way, with the buyer allegedly misrepresenting facts. Many agencies keep inadequate records, either because they don't know any better or simply don't care. As a result, many sellers unintentionally misrepresent themselves, while many buyers do a lame job of conducting due diligence. That's a deadly combination.
Every potential buyer and seller should take steps to avoid scenarios like the one above. Here's how:
Do due diligence! A formal definition of due diligence goes something like this: “The process of investigation, performed by investors, into the details of a potential investment, such as an examination of operations and management and the verification of material facts.” In other words, buyers must make sure they know exactly what they're buying.
Due diligence typically starts with the seller answering a long list of questions and providing copies of certain documents. The buyer analyzes this information to get an accurate picture of the state of the seller's operations. For example, one of the many questions a buyer can answer through due diligence is whether the seller is in trust. The data to determine an agency's trust position are easy to obtain and the calculation is simple. If a buyer uses proper due diligence, it's very difficult for an agency to hide that it's out of trust.
Due diligence will also uncover misrepresentations, intentional or otherwise. Most, if not all, sellers tout the robust health of their agencies. They view their businesses as financially sound, even if they're not. Due diligence, however, will determine the accuracy of such rosy assessments.
I suggest buyers combine analysis of the seller's data and documents with on-site due diligence. On-site due diligence, performed by an outside consultant, can pay significant dividends. A buyer cannot appear on-site without employees becoming suspicious, which will greatly limit his or her ability to observe and investigate. A consultant, however, can work among employees without raising concerns. As a consultant doing on-site due diligence, I've discovered fraud, forgery, E&O claims and significant exposures, news of producers leaving, interoffice romances and serious operational problems–problems owners themselves may not know exist.
Many business brokers, finders and consultants opt to avoid significant due diligence because it delays closing the deal, can be costly and time-consuming, and may lead to more negotiations. If the broker is paid on commission (as many are), investing more time in a deal cuts into profits. Regardless, thorough due diligence should be non-negotiable. Insist on it, no matter how much others try to talk you into cutting corners.
Resist pressure to sign. Never cave in to pressure to “do the deal” quickly. A smart deal takes time. It takes two to four weeks for a seller to gather the necessary data for adequate due diligence. It requires another two to four weeks to analyze the data–assuming it's complete and sound. If it's not, add several more weeks.
Some brokers have a nickname for attorneys and consultants who want to carefully go through the details of a purchase. They call them “deal-busters.” Ignore such talk. The right attorney, accountant and consultant will help you do the right deal–fast, slow or in between.
Don't expect GAAP standards. Many agencies have poor accounting practices. Few meet generally accepted accounting principles (GAAP) standards. Many have unaudited financial statements that almost certainly won't meet GAAP standards. Expect to have to dig into the seller's financials to make sure the data make financial sense. If they don't, take the time to get an explanation.
Sellers, make sure your numbers add up! When an agency keeps incomplete or sloppy records, books and data, the result is a lower-priced business and reduced marketability. Sellers should make sure their records and data reconcile at least three years before attempting to sell the business. Sellers who aren't sure they can identify all the inconsistencies themselves–and many cannot–should hire someone to help.
If your adviser discovers your agency has serious accounting problems, don't kill the messenger. Embrace him or her for helping you improve your business so you can get the right price when it's time to sell. Does it make sense to have a buyer discover during due diligence that your agency is worth less than expected, rather than first finding out yourself and doing something about it?
Create your own pro forma balance sheet. Balance sheets are important financial statements. Nevertheless, many buyers and sellers ignore them either because they're lazy or they lack adequate financial background. Additionally, balance sheets are often inaccurate for acquisition purposes–particularly ones that comply with GAAP. Therefore, it's critical for buyers and sellers to create pro forma balance sheets that reflect reality. Doing so makes them non-GAAP compliant, but the information gained is essential.
Caveat emptor. There's never any reason to rush into an acquisition. Proper preparation can uncover warning signs and pave the way for a smooth deal. Don't buy an agency only to find that it fails to meet your expectations. Don't sell an agency only to find you could have gotten more for it had you been better prepared. The stakes are high, so do your homework–whether you're buying or selling.
Chris Burand is president of Burand & Associates LLC, an agency consulting firm. Readers may contact Chris at (719) 485-3868 or by e-mail at [email protected].