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

Unfortunately, this situation is not unusual. Buyers oftendiscover unpleasant surprises when the deal is done. Sometimes itgoes the other way, with the buyer allegedly misrepresenting facts.Many agencies keep inadequate records, either because they don'tknow any better or simply don't care. As a result, many sellersunintentionally misrepresent themselves, while many buyers do alame job of conducting due diligence. That's a deadlycombination.
Every potential buyer and seller should take steps to avoidscenarios like the one above. Here's how:
Do due diligence! A formal definition ofdue diligence goes something like this: “The process ofinvestigation, performed by investors, into the details of apotential investment, such as an examination of operations andmanagement 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 longlist of questions and providing copies of certain documents. Thebuyer analyzes this information to get an accurate picture of thestate of the seller's operations. For example, one of the manyquestions a buyer can answer through due diligence is whether theseller is in trust. The data to determine an agency's trustposition are easy to obtain and the calculation is simple. If abuyer uses proper due diligence, it's very difficult for an agencyto hide that it's out of trust.
Due diligence will also uncover misrepresentations, intentional orotherwise. Most, if not all, sellers tout the robust health oftheir agencies. They view their businesses as financially sound,even if they're not. Due diligence, however, will determine theaccuracy of such rosy assessments.
I suggest buyers combine analysis of the seller's data anddocuments 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 becomingsuspicious, which will greatly limit his or her ability to observeand investigate. A consultant, however, can work among employeeswithout raising concerns. As a consultant doing on-site duediligence, I've discovered fraud, forgery, E&O claims andsignificant exposures, news of producers leaving, interofficeromances and serious operational problems–problems ownersthemselves may not know exist.
Many business brokers, finders and consultants opt to avoidsignificant due diligence because it delays closing the deal, canbe costly and time-consuming, and may lead to more negotiations. Ifthe broker is paid on commission (as many are), investing more timein a deal cuts into profits. Regardless, thorough due diligenceshould be non-negotiable. Insist on it, no matter how much otherstry to talk you into cutting corners.
Resist pressure to sign. Never cave in to pressureto “do the deal” quickly. A smart deal takes time. It takes two tofour weeks for a seller to gather the necessary data for adequatedue diligence. It requires another two to four weeks to analyze thedata–assuming it's complete and sound. If it's not, add severalmore weeks.
Some brokers have a nickname for attorneys and consultants who wantto carefully go through the details of a purchase. They call them“deal-busters.” Ignore such talk. The right attorney, accountantand consultant will help you do the right deal–fast, slowor in between.
Don't expect GAAP standards. Many agencies havepoor accounting practices. Few meet generally accepted accountingprinciples (GAAP) standards. Many have unaudited financialstatements that almost certainly won't meet GAAP standards. Expectto have to dig into the seller's financials to make sure the datamake financial sense. If they don't, take the time to get anexplanation.
Sellers, make sure your numbers add up! When anagency keeps incomplete or sloppy records, books and data, theresult is a lower-priced business and reduced marketability.Sellers should make sure their records and data reconcile at leastthree years before attempting to sell the business. Sellers whoaren't sure they can identify all the inconsistenciesthemselves–and many cannot–should hire someone to help.
If your adviser discovers your agency has serious accountingproblems, don't kill the messenger. Embrace him or her for helpingyou improve your business so you can get the right price when it'stime to sell. Does it make sense to have a buyer discover duringdue diligence that your agency is worth less than expected, ratherthan first finding out yourself and doing something about it?
Create your own pro forma balance sheet. Balancesheets are important financial statements. Nevertheless, manybuyers and sellers ignore them either because they're lazy or theylack adequate financial background. Additionally, balance sheetsare often inaccurate for acquisition purposes–particularly onesthat comply with GAAP. Therefore, it's critical for buyers andsellers to create pro forma balance sheets that reflect reality.Doing so makes them non-GAAP compliant, but the information gainedis essential.
Caveat emptor. There's never any reason to rushinto an acquisition. Proper preparation can uncover warning signsand pave the way for a smooth deal. Don't buy an agency only tofind that it fails to meet your expectations. Don't sell an agencyonly to find you could have gotten more for it had you been betterprepared. The stakes are high, so do your homework–whether you'rebuying or selling.
Chris Burand is president of Burand & Associates LLC, anagency consulting firm. Readers may contact Chris at (719) 485-3868or by e-mail at [email protected].