| Introduction:
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| | auto repair shops; real estate services
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| This article is written as a general
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| | contractors, non-real estate repair/
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| discussion on the subject of "Due
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| | services, and retail stores.Restaurants-
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| Diligence". It is for informational
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| | Non-Franchise:
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| purposes and not intended to be a
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| | Restaurants compose over 25% of all
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| definitive guideline for your exact
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| | businesses for sale. This is not because
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| situation. You should consult the
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| | they all go broke, as the SBA reports. It
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| appropriate professionals with regard to
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| | is because 28% of all retail businesses
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| your specific transaction or situation.
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| | are food service or food sales. It is the
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| Further, this article is in no way
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| | largest segment of the consumer market.
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| advocating, suggesting or implying that
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| | Because it is a retail consumer business,
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| anyone engages in any type fraudulent
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| | it deals in 33% cash. Every
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| activities whatsoever. These are simply
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| | independent-non-franchise food service
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| the things a buyer should be aware of
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| | business I have been into shows zero
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| when doing due diligence in buyer a
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| | profit on the books. Some even go
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| business.Due Diligence Defined:
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| | overboard and show a tax loss. It is
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| The phrase is composed of two words.
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| | because they do simple tax planning that
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| "Due" which the dictionary defines as
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| | does not require an MBA degree to figure
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| "Proper or Adequate" and Diligence, which
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| | out. If the business doesn't show all of
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| is defined as "Degree of care or caution
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| | its cash, or any of its cash, the
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| expected of a person. Especially as a
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| | expenses will equal the reported income.
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| party to an agreement." Caution: is the
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| | This alone makes it attractive to many
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| watchword in this definition.Financial
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| | buyers. We will not discuss the moral
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| Statements - What to look for:Add Backs:
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| | issues of this attitude; it is what it
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| If you bought the business through a
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| | is. What we have to discuss is how do
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| business broker you should have received
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| | you, the buyer, can prove that the
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| the business financial statement with a
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| | business is making a profit? And if it
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| separate worksheet showing adjustments to
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| | is, how much?Restaurants come in two
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| those statements. These adjustments show
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| | categories. 1. Fast food-counter sales.
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| the owner's benefits received from the
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| | 2. Sit down. Fast food restaurants have
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| business besides the profit and salary he
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| | computerized cash registers that record
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| receives. These can also be defined as
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| | the sales into its computer, which has a
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| personal expenses that need to be added
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| | memory. This memory has daily totals
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| back to the profit. Depreciation, incomes
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| | going back to the beginning of the
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| taxes, interest expense are add backs
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| | computer's history. Most owners close out
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| that are not personal. Personal includes
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| | their cash registers at the end of the
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| such things as family auto expenses,
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| | day and print out the tape of each day's
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| owner life insurance, owner health
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| | activities. This does not automatically
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| insurance, business entertainment that
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| | wipe out the information for the day. The
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| was not really spent on clients, business
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| | computer does, I am told, have a delete
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| trips not really for business, home
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| | button on it allowing the owner to wipe
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| office expenses, family cellular phones
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| | out the full memory in the computer, in
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| and much much more.Make the seller show
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| | the event of an audit. I have also been
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| you the details on some or all of these
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| | told, but do not believe, that an
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| expenses to verify that they are really
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| | electrical blackout can wipe out the
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| personal and not actually business
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| | memory in the computer and that is why
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| expenses that shouldn't be added back to
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| | one seller said he couldn't give me
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| profit. Spend time asking detailed
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| | access to this information.If we are
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| questions with the general ledger in
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| | talking about a sit down restaurant sales
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| front of you. Go through individual
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| | information, you can use the daily order
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| charges and what they mean, until you
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| | ticket, which are then imputed into the
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| fully understand what is being added back
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| | computer. This gives 3 sources: tickets,
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| and why.Inventory:
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| | computer and daily tape totals.When this
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| Inventory of resale merchandise must be
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| | information is not available, for any
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| checked for two reasons. One is you have
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| | reason, an experienced restaurant
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| to pay for it. Be careful, you do not
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| | consultant can tell you the sales
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| want to buy merchandise that is old,
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| | activities just by inspecting the
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| worthless and not saleable anymore. Only
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| | restaurant and counting the number of
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| pay for current marketable product. The
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| | customers eating at 4 key times in a day,
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| price you are suppose to te pay for the
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| | and on several key days per week. Then
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| inventory is the seller's cost. The price
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| | the consultant can figures out what the
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| for old slow inventory is negotiable.
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| | average sales ticket amount is. With this
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| Always spot check the price and count the
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| | information like magic the consultant
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| merchandise listed on the inventory list.
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| | knows the gross sales figure, for the
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| Do people put down that there is three of
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| | year.A double check procedure for
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| an item when there are only two? Of
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| | restaurant consultants is to then look at
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| course, especially when they think no one
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| | the food purchases and its costs and can
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| is going to be checking them out.
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| | confirm that it matches the actual sales
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| Comparing prices from purchase invoices
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| | figures. One consultant that was hired
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| is how you check prices. You cannot check
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| | to review a Johnny Rocket restaurant for
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| every item against the actual cost but
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| | $7,000 did the audit and put together a
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| you can do 5% of the items. Pick at
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| | marketing program for the buyer. The
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| random, not by any suggestion made by the
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| | marketing program included delivery and
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| seller or others. If you do not
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| | catering. Both of which do not normally
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| understand how marketable the inventory
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| | show up on the computerized cash
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| is that you are buying, hire an expert,
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| | register.Restaurants - Franchise:
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| from that industry. Your broker should be
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| | You would imagine that franchise
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| able to help you in finding someone. Do
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| | restaurants records would be very
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| not be cheap, and think you do not need
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| | accurate because the franchise company
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| to spend the money on an expert adviser.
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| | gets a percentage of the gross income.
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| I will take a lunch bet that they will
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| | The bigger ones connect up to the
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| pay for them selves many times over.The
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| | individual franchise and know what is
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| second reason for checking inventory is
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| | happening faster then the owner. As
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| that if a seller doesn't take inventory
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| | stated above, the only sales that can be
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| at least yearly and adjust his inventory
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| | made and not declared to the computer are
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| value in his accounting records,
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| | catering or delivery orders, which could
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| accurately, the profit figure you are
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| | be done without ringing them up.Some
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| receiving will not be accurate. As a
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| | franchises do not hook up to the
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| rule, the higher cost of goods sold, the
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| | individual franchise computers and do not
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| lower the profit. Some business owners
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| | do audits regularly. This allows the
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| reduce the inventory value on the books,
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| | franchise to report reduced income to the
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| intentionally, to a lower value so as to
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| | company and the IRS. In case either comes
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| make the business show a higher cost of
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| | to audit, they press the delete button on
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| goods sold, which then creates a smaller
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| | the computer. If you as a buyer can get
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| taxable profit. If they do this year
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| | access to the computer you know the
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| after year, the profit may or may not be
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| | numbers are correct even if they are not
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| accurate for the current year. It might
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| | complete. It is impossible for the staff
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| take a CPA to figure this one out for
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| | or the owner to change the computer
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| you, if you do not have a background in
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| | records. The information can only be
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| retail.Equipment value:
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| | deleted. Again catering and take out may
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| Next thing to check on the financials is
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| | not be on the computer. Theft from
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| the real, current value of the equipment
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| | employees can only be in the form of 1.
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| you are buying with the business. The
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| | Employees that give free food to friends.
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| balance sheet might, if it shows all the
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| | 2. Employees not ringing up an order,
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| equipment the company owns, give you the
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| | which is difficult when businesses put up
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| cost of the equipment when it was
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| | signs saying, "If you do not get a
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| purchased. If you are buying assets
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| | receipt, your order is free."Some sellers
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| rather than cash flow, the equipment
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| | are so paranoid of the IRS, they are not
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| valuation becomes more important. No one
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| | willing to show anyone their private
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| wants to overpay for used equipment. Also
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| | records or computer tapes for fear that
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| check that the equipment works and is
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| | the buyer could be an IRS agent. My
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| actually being used rather than sitting
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| | personal opinion, and what I advice
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| behind the building with other junk.Cash
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| | sellers to do, is to get their books
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| Sales:
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| | legal and honest and hire themselves a
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| If all income is being reported, check
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| | top notch CPA, like Donald Trump, and use
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| sales volume activities that you have
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| | every legal trick in the book. Martha
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| observed against the daily records during
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| | Stewart didn't go to jail for inside
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| your "Due Diligence" to see if the volume
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| | trading. They got her on lying. There are
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| corresponds to what was reported last
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| | legal ways to avoid taxes so that fraud
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| year in the same month. If you see income
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| | is not necessary. If you cannot find a
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| of $500 per day but the seller shows
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| | good accountant, I will recommend one.If
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| sales of $1,000 per day, you need to find
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| | you ask someone "Are you a government
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| out why. Some smart buyers sit in the
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| | employee or IRS agent?" and they lie to
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| business all day, watch the sales and
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| | you; that might be considered entrapment
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| observe the activities of the staff. This
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| | and a good possible defense in court.
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| works if the seller is not putting on a
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| | But, I ask you. Is it worth the grief?The
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| full fledge production fraud for you the
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| | normal action of sellers, in this
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| buyer.Fraud:
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| | situation, is to require that the buyer
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| How does a seller defraud a buyer on
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| | take the business based on the recorded
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| current sales activity levels? Sellers
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| | records and guess as to how profitable
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| who keep poor records or no records, many
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| | the place really is. This is a very
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| times, suggest the buyer doing a 15-day
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| | difficult situation for the brokers and
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| visual inspection. This helps but it is
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| | buyers, since sellers do not price their
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| very dangerous to rely solely on physical
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| | business based on these reported numbers
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| inspections alone because the seller can
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| | but base their price on the real
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| still defraud the buyer. Here is the most
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| | numbers.I hope this is of some help to
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| famous of the stories I have heard over
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| | you in doing due diligence on a
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| the years.Seller owns a dry cleaner. The
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| | restaurant you might be interested in
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| buyer and seller have opened escrow and
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| | buying.Auto Repair Shops:
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| the deal is subject to a 15-day physical
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| | Auto repair shops are almost as bad as
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| observation period. The seller doesn't
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| | restaurants when it comes to
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| want the buyer to find out that business
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| | under-declaring cash. The normal
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| volume is very slow. The seller tells all
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| | procedure for most, I have run across, is
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| his friends to bring their dry cleaning
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| | to declare only the checks and credit
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| in to the shop for a two-week period, at
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| | card charges. The cash they put into
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| no charge. They bring in the clothing,
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| | their pocket. The good thing, in doing
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| get it cleaned, pick it up and pay for
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| | audits is that almost every one of these
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| it. Later the business owner meets the
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| | owners keeps their work orders-invoices.
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| customers and reimburses all of them for
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| | These are kept in monthly manila folders
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| the cost of their dry cleaning. The day
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| | and put into a drawer or file cabinet.
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| after escrow closes all that business
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| | They never tell you that they keep these
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| traffic stops. Think it never happens?
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| | records, but they do. They even tell me,
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| The same is true of restaurants. Seller
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| | as the broker, that all backup documents
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| tells all his friends to bring all of
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| | have been destroyed, but they are not.
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| their friends in for a free meal.
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| | When I insist that they cannot sell their
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| Customers pay the bill and some time
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| | business without providing these
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| later or at home, the business owner
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| | invoices, they tell me of their
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| reimburses all the customers for the cost
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| | existence.With the sales invoices an
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| of their meals.Actual time sellers spends
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| | audit of income becomes simple. Since the
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| working:
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| | sellers keep them in a manila folder by
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| Determine how many hours the seller
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| | months, you only have to pick monthly
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| really works. You are buying an income
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| | folders at random and total the actual
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| stream based on a known number of hours
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| | invoices. Then compare them to what the
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| of work. Make sure the seller isn't
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| | "State Board of Equalization" report says
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| working 80 hours and telling you he is
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| | and calculate what percentage of the
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| only working 40 hours, per week. I had an
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| | total was declared. If you do this for a
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| absentee fast food owner tell the buyers
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| | few months, a pattern will develop. Some
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| and me that he worked part time - 5 hours
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| | sellers have even run a calculator tape
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| per week. Closer inspection showed he was
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| | of the month's activities and/or written
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| working 25 hours per week. One auto
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| | it in a private ledger. You can check the
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| repair seller, we'll call him Bob, said
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| | actual invoice tapes against the private
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| he never was at the business, because he
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| | ledger records to confirm the private
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| had a second full time job. Inspection
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| | ledger information is correct.Conclusion:
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| found he was working 30 hours a week (4
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| | It is a hard life when you own your own
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| plus hours every night, and 8 hours on
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| | business; you work long hours. Many
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| Saturdays).Find out what job functions
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| | people feel that is better than the
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| the seller does:
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| | alternative, which is to work for someone
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| Get a list of functions that the seller
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| | else, pay high taxes, never know if you
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| does. Is one of them bookkeeping?
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| | will be laid off and after years of hard
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| Sometimes the wife does the books part
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| | work, never have anything to show for it
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| time and this is never said. Again you
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| | all.If you are going to buy a business
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| may find the owner does the bookkeeping,
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| | with your hard earned money, you want to
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| at home, every night, for an extra hour.
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| | make sure you get what you paid for. Many
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| In an auto repair shop, you may find the
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| | people believe it is all right to cheat
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| owner is doing auto body repair work,
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| | the taxman but otherwise are very honest
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| personally, on Saturdays, which is work
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| | citizens. Others feel it is all right to
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| that you, as a buyer, will never be able
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| | cheap any poor sucker that comes along.
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| to duplicate. You need to be sure you
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| | Don't be a sucker, do your due diligence
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| know how to do every job function that
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| | and get what you paid for.Then build your
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| the seller does or learn them. The time
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| | new business into something you can be
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| to find out what technical knowledge you
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| | proud of and enjoy. While building your
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| need to have to take over the business is
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| | new business make a point to study
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| when you are doing your investigation,
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| | everything you can about Tax planning,
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| not the day after escrow
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| | tax avoidance and reducing taxes legally.
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| closes.Verification of things that are
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| | I started in College learning about the
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| not on the Financial Statements:
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| | tax codes, and there are so many ways to
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| It is a common occurrence that
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| | save taxes legally, you would never
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| businesses do not record all of their
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| | believe it. You will sleep better at
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| income on their financial statements.
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| | night, I promise you. Then 10-20 years
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| Yes, this is true. Many people do not, in
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| | from now when you want to sell your
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| fact, report the truth on their tax
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| | business, you can ask top dollar and get
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| returns. In fact, when I am talking about
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| | it. This because a buyer can do a simple
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| small retail or service businesses that
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| | due diligence and know that your business
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| deal with the public directly, I find it
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| | is doing exactly what your books say you
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| is over 90%. "Will the people with an
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| | are doing.DO YOUR DUE DILIGENCE and
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| honest set of books, please leave the
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| | buying your own business can be a
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| auditorium. There are two golf carts
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| | pleasant and rewarding experience!Willard
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| outside waiting to chauffer you home. You
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| | Michlin is an Investor, Business Broker,
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| do not need to hear this."The balance of
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| | California Real Estate Broker,
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| this article will discuss how a buyer
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| | Accountant, Financial Distress
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| might do their "Due Diligence" for
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| | Consultant, Well known Public speaker and
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| different types of businesses. These
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| | Administrative/Business Consultant.
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| types of businesses include Restaurants,
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