The buyer concludes it overpaid for the business and stops making deferred purchase price payments. Both the trial and the appellate court conclude that the buyer breached the acquisition agreements. They order the buyer and its owner (as guarantor) to pay the remaining purchase price and seller’s legal fees and costs.
M&A Stories
May 6, 2023
Introduction
It is important for buyers to conduct due diligence before purchasing a business.
During due diligence, the buyer should conduct a thorough review of the business’ financial statements, contracts, legal and regulatory compliance, operations, and other relevant information. The goal of due diligence is to identify any potential risks and liabilities associated with the business and to ensure that the buyer has a complete and accurate understanding of the business’ value and potential.
Overall, due diligence is a critical step in the M&A process as it allows the buyer to make informed decisions and negotiate terms based on a comprehensive understanding of the business.
The buyer in this case failed to do so and overpaid for the business.
The deal
The seller was an Indiana business providing heating, air conditioning, commercial refrigeration, and ice machine services. The business was essentially a one man operation consisting of the seller owner.
After 30 years, the seller owner decided to retire. The buyer was interested in purchasing the business after reviewing the seller’s recent profit/loss statements, balance sheets, and tax returns.
The buyer requested to see the service contracts, but none were available. There were also no billing records, other than job invoices. The seller’s customers paid the seller upon completion of the service and the only records were the job invoices.
Based upon the above due diligence the buyer agreed to purchase the business for $150K, twenty percent down, with the balance payable over four years at 5% interest. The parties executed an asset purchase agreement, promissory note, security agreement, and a personal guaranty was given by the buyer’s owner.
After the closing the seller delivered five years of job invoices. The buyer had not asked nor reviewed the job invoices before closing.
The lawsuit
The buyer defaulted on the promissory note 4 months after the closing. The seller sued the buyer and its owner in an Indiana state court to recover the balance of the purchase price. The buyer counterclaimed, accusing the seller of breach of contract and fraud.
The trial court held that the buyer was not excused from paying the balance of the purchase price because the seller did not breach acquisition agreements nor did the seller commit fraud. The court found that the buyer’s failure to investigate and evaluate the business before agreeing to the deal led to the possibility of overpayment.
The court said that the buyer could have reviewed the job invoices. Therefore, the court ordered the buyer to pay the seller the remaining $125K of the purchase price and reimburse the seller for its legal fees and costs.
The buyer appealed to an intermediate court of appeal. The appellate court upheld the judgment of the trial court.
See Gudorf v. McAndrew, Court of Appeals Case No. 22A-PL-1809, Court of Appeals of Indiana (April 6, 2023.)
Comment
I don’t know whether a buyer review of the job invoices would have influenced the buyer’s purchase decision. However, they were available and could have given the buyer the names of customers to talk to, and also to match up the job invoice amounts to the revenue reported on the tax returns and profit and loss statements.
By John McCauley: I write about recent legal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
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Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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