Last week, Crain’s reported that Brow Truss coffee houses had closed their doors. Left behind are dozens of employees with unpaid wages and one hysterical owner who is blaming the guy who backed away from buying him out. Marcus Lemonis, the star of MSNBC’s The Profit, had agreed to buy most of the business on the standard condition that the financial records didn’t turn out to be fishy. Unfortunately, after months of due diligence, the Lemonis team has concluded that the books are, in fact, fishy.

There are three big lessons for all entrepreneurs about how to run your business and your negotiations if you want to do a deal with an investor.

  • Keep it Separated:  Lemonis claims that Bow Truss’s financial accounts were mixed up together with another company’s financial accounts, making it impossible to slice off just Bow Truss. Like the old (not very good) 90’s song said, “you’ve got to keep it separated.” One company needs to stay totally independent from every other company. Separate accounts, separate checks, separate expenses, separate revenues. If you must mix two or more companies, do it under a Services Agreement and show clearly payments going back and forth and the reasons for them. Not only can co-mingling assets kill a deal, but it can also destroy the limited liability shield of your entity.
  • Books Matter: The state of financial and legal records matters in getting funding or getting acquired. If the books and records are shoddy and shabby, it gives the investor pause about the competence of the business. Sloppy or incomplete books and records can also delay a deal until it is no longer feasible. Or, the books and records can fail to show how good a business is. A few years ago, I interviewed a business broker on my radio show, who told me the most amazing thing. Many small business owners skim a bit off the top, reducing the amount of revenues they report on their tax returns. The impact of this practice is that, in addition to cheating on taxes, funding falls through because those business records show a business making too little money. I know from my work with banks and investors that artificially deflating revenues is a common syndrome. Now, there is no indication that Bow Truss was deflating its numbers. But, the deal died because the Lemonis team couldn’t piece together an accurate picture of the company’s results.
  • Don’t Underestimate Your Debts: Here is Lemonis talking about what he found during due diligence: “Through the due diligence process, I learned several things I just didn’t like,” Lemonis said. “Phil never told me that all of the rents were past due. He never told me he had a habit of bouncing paychecks, and he never told me he was collecting insurance premiums out of employees’ checks but not remitting their portion or the company’s portion to their insurance company.”

During an investment or acquisition, the company and the investor will negotiate on terms and look at some financial statements and a business plan. But, at some point, the investor will enter due diligence, “a deep examination of every piece of paper involving the company.” Surprises in due diligence can be disruptive or fatal to a deal. Not only can the economic assumptions about the deal change, necessitating new negotiations, but the owners can also lose all integrity, forcing the investors to wonder if anything they see is real.