When is it fraud?

[Bobjob]

When selling a business, when is the asking price or sale price considered fraud? I realize there is goodwill. But if on paper a business is worth 2 million, and they are asking 4.5, is this fraudulent?

[Harold Mansfield]

When selling a business, when is the asking price or sale price considered fraud? I realize there is goodwill. But if on paper a business is worth 2 million, and they are asking 4.5, is this fraudulent?

Nope. You can ask whatever you want. It's worth what someone is willing to pay. However, if you deliberately hide things like broken equipment, debts, if you're under criminal investigation, structural damage to buildings and things like that with the intent to deceive then that's fraud.

[Freelancier]

It's only fraud if you misrepresent facts. A valuation is only an opinion. If you say something is going to cost $10 and then charge them $100 without their consent to the price change, that's fraud. If you say it's going to cost $100 and charge them $100, doesn't matter what it is "worth", since worth and value are based entirely on an opinion.

[Bobjob]

I thought that was what y'all were gonna say. Thanks.

[BobOlmstead]

There is a very set process most commonly called, Due Diligence, designed to avert getting into something that was not as promised. In fact, there are entire firms that specialize just in due diligence. In order for criminal fraud (key combo of words) to be present, several factors need to exist. Someone overselling the value or potential of a business, in and of itself, rarely meets the acid test of criminal fraud. However, that ONLY relates to criminal fraud. If an attorney feels there is cause for a civil suit, that is a different set of rules.

[turboguy]

I would like to ask how you are coming up with your 2 million valuation. Some people look at the balance sheet and figure whatever the assets are minus the liabilities is what a company is worth. Companies are more often valued on either their ability to produce a profit or their potential ability to either grow, have the potential for future profit or both. Scale-ability can also affect price. I would expect a company priced at 4.5 million to be producing profits of at least $ 650,000 with $ 500,000 being the minimum to generate that valuation. I would expect sales to be at least 4.5 million a year as well.

[Bobjob]

Turbo I was just making up a number for examples sake. For better example my accountant audits my business and says it's worth about 2 million for everything (land, office/warehouse, inventory, customer list, everything) and I try and sell it for 4.5 would it be fraud? It is not, I would just be silly. For the record I'm not selling I was just curious. I knew you could ask any price for property, I just wasn't sure about a business.

What is common for how is net cash in the bank handled when selling? You and the buyer adjust however y'all want it for the final sale price?

[turboguy]

Generally the best way to determine the value of a business is to do a full business valuation which is usually done by a specialist rather than an accountant but a good accounting firm may have one on staff or that he works with. If you have ever watched Shark Tank you will see business valuations that are all over the map but it is not illegal to price a business any way you want. It would not be fraud. If you look at the stock market which has some similarity in that when you buy stock you are in theory buying a part ownership in the business. You will see some companies that have very low values in comparison to the amount of money they can earn. Ford is a good example of that. You will see others that have sky high valuations. Amazon and Netflix would be examples of those. You can price your business that is worth 2 million for 2 billion if you want and it isn't illegal. The thing is you probably will have a hard time finding someone to pay that 2 billion.

When you buy a business assuming it is on going things like cash, AR and inventory change every day. This can be handled many ways but usually the purchase agreement will spell this out. There will be a closing date and any cash changes would not be a big deal since if inventory went down sales and either cash or AR would go up. Any major withdrawals that were out of the ordinary would not be allowed but this would be covered in the agreement. In other words if you sold a business that had a half million in AR and a half million in cash you could not just pull out the half million just before closing. Ordinary withdraws and normal fluctuations would not be a problem.

Oddly enough my major competitor called me yesterday wanting to buy my business. I am not sure if he is serious or just looking for info that would be unavailable to him otherwise about our finances and direction.

[Freelancier]

I am not sure if he is serious or just looking for info that would be unavailable to him otherwise about our finances and direction.
There is a "clean room" process you can insist on so that he does not get specific data about your business directly. Talk with an attorney familiar with these types of activities about things you can do to isolate out anything that might be considered "proprietary" about your business.

[Business Attorney]

There are many things that go into the valuation of a business, and different things are going to be more important than others to different buyers. A financial buyer is typically going to look solely to a return on its investment. A strategic buyer is not going to ignore the cash-on-cash return but may be more interested in other factors.

Does the business allow it to gain market share that will give it better pricing power? Does the business give it a foothold in new markets for its existing products? Does the business give it access to new products it can sell through its existing business channels? All those and more may affect the price a strategic buyer might pay.

Even one financial buyer may evaluate the business different from another financial buyer. Although businesses are usually valued based on multiples of historic earnings, in fact those historic earnings are only approximations of what is really important: future earnings. Sophisticated buyers use past earnings, existing trends and expected changes to generate forecasts for future cash flows, which are then discounted to present value. That may sound simple but since no one can really predict the future, one buyer may have a markedly more optimistic view of the future prospects for the business, and therefore may pay a higher price.

All of that comes back to what you, as the seller, can do. You can ask whatever price you want but it is just an asking price. You are not telling the buyer what the business is worth, you are telling the buyer what you want to sell it for. That is a big difference.

As long as you don't misrepresent facts relating to the business, there is no fraud. Telling the potential buyer your asking price, and even telling the buyer the logic behind why you think you should get that price, is simply stating your opinion.