Trust But Verify: How to Safeguard Your Investment When Buying a Business

 When buying a business, the most valuable asset you can bring to the table isn’t just capital—it’s caution. Assessing the credibility of a seller’s information can be challenging, especially when it’s your money on the line. In response to a reader’s question, here’s a breakdown of the techniques and safeguards you need to make confident, well-informed business acquisition decisions. https://www.youtube.com/watch?v=BRXkzlGagsA

1. The Golden Rule: Trust, Then Verify

“Trust, but verify.” When evaluating a business, always cross-check claims with objective data. For instance, in restaurants, a 50-50 cash-to-card sales split is common (this was made before the pandemic. The card percentage is much higher now); if card sales are around 50%, cash claims are likely reliable. Similarly, in bars, comparing reported sales to official liquor purchase records confirms accuracy.

2. Watch for Red Flags in Financial Statements

In business acquisitions, financials aren’t foolproof. If property taxes seem to drop annually, investigate—it might signal unpaid taxes, not savings. Ask tough questions and probe the details.

Understanding Types of Financial Statements: Accountants generally prepare three levels of financial statements, and knowing the distinctions will help you gauge how thoroughly a business’s numbers have been vetted:

● Notice to Reader: Simply formatted financial statements based on the owner’s information without any verification.

● Review Engagement: A moderate review where the accountant flags inconsistencies and seeks explanations from the owner.

● Audit: An in-depth investigation, though rare in smaller businesses due to higher costs. If a seller only has a Notice to Reader report, consider investing more effort into verification, as

these statements haven’t undergone any fact-checking.

3. Structuring the Deal to Protect Against Misrepresentation

When it’s not possible to rely fully on provided information, structure the deal to include protections. One effective method is to include a Vendor Take-Back (VTB) Note or Seller Financing. Here’s how this works:

  

 ● Suppose you’re purchasing a small restaurant valued at $100,000. Let’s say the assets—equipment, inventory—are worth $60,000. Banks might lend up to 75% of this asset value, covering $45,000. You might put in $30,000, leaving $25,000 as a balance. Here’s where seller financing comes in: instead of paying the entire sum, you offer $75,000 upfront and leave the remaining $25,000 as a vendor note, which acts as a loan from the seller.

● Why This Protects You: Include a clause in the vendor note stating that if the seller misrepresents any significant details or has hidden liabilities, you can withhold payments. This shifts the risk of misrepresentation back onto the seller.

4. Red Flags When a Seller Refuses Vendor Financing

If a seller resists including a vendor note, it’s often a sign to proceed cautiously. The seller might have doubts about the business’s accuracy or your ability to manage it, both of which are red flags that warrant careful re-evaluation of the deal.

Conclusion and Key Takeaways

Buying a business is no small investment, and due diligence is essential. Verification, financial statement comprehension, and deal structuring all serve as tools to help protect your investment. A well-structured vendor note can also act as a deterrent against misrepresentation, ensuring that sellers stand by their word.