Owning a business is the dream of a lot of people, but buying a business can be a nightmare. To facilitate the process, business brokers attempt to hook up sellers and buyers, and they know that getting a worn-out seller with a naive buyer is a very tricky endeavor that often goes sour before or after the sale.
Everybody knows that nobody wants to sell a gold mine, but they do want to put the best face on what they’ve got to sell and make a plausible story for why the owner wants out. Often the sale is due to the “owner’s health,” which can mean just about anything. Sometimes, the seller or the seller’s agent pooh-poohs the scant income on the tax returns, implying that the business throws off a lot of cash that never gets reported.
Business brokers run the full gamut from extraordinarily knowledgeable and helpful to pure cosmeticians. There is one business brokerage firm that I love to work with because of their expertise and integrity–the Kingsley Group, in Springfield, Missouri.
Some business brokers are people who may have bought a business brokerage franchise, but lack the depth of experience to really understand how to find the right business for the right buyer and to assemble the right package of materials (financial statements, tax returns, inventories, asset lists, customer lists, intellectual property, contracts, etc.) so that the business being sold is fairly portrayed to the buyer. The pressure on the broker to close a deal gets ahead of the idea of making sure that the business for sale is presented fairly and completely and that the buyer knows what the buyer is getting into. Even if financial statements show an exaggerated picture of value, a court isn’t necessarily going to come to the rescue of the buyer.
A recent Arkansas Court of Appeals decision, Sunbelt Business Brokers of Arkansas v. James, involving a couple of Subway sandwich shops, describes a fairly common set of events. James got a bunch of financial statements from Sunbelt, showing substantial income for the owner, but the revenues and profits of the business didn’t even come close in the first year to what the seller supposedly earned in previous years. James sued the business broker, its agent and the former owner for fraud, and the trial court awarded her a handsome settlement. Sunbelt had provided James with a cash-flow statement on Sunbelt’s form which showed a nice salary for the previous owner, even though in the trial the owner admitted that no salary had been taken.
But fraud requires not only proof of misrepresentation and proof of intent to misrepresent, but proof that the buyer justifiably relied on the misrepresentation to her detriment. The appellate court thought that the buyer knew better than to have relied on the amateurish cash-flow statement. James was a financial services advisor and financial consultant and her husband was a CPA, formerly chief financial officer for a company that owned a string of Subways in another state. Before closing, they asked for and received tax returns and other more reliable information about the health of the Subway stores they bought through the business broker.
Even though the issue of whether reliance is justified is a fact issue for the trial court, the Arkansas Court of Appeals was certain enough to reverse the verdict, finding that there was no reliance and thus no fraud, when the buyers surely knew better than to believe the misinformation they were given.
Any experienced lawyer will advise that proving all the elements of fraud is very, very tough. Even though misrepresentation in business transactions is common, it’s really difficult to prove to a judge or jury that the misrepresentation happened, that it was intentional, that it was “material” (meaning significant, not trivial), and that the victim relied on the misrepresentation and was damaged as a result.