How not to evaluate the possible purchase of a business.
In 1987 Lauren Karpinski, then the director of international trade and customs for accounting firm Arthur Andersen, faced a tough choice: to accept a transfer from her Orlando office or stay close to her family. Family ties won. "But I told my husband," she recalls, "that if I were going to leave a perfect job, I wanted to buy a business." Her second requirement was to buy it fast -- within six weeks, while still on her employer's payroll.
So began the nightmare for the Karpinskis, who spent $750,000 to buy a Port Canaveral marina that was probably worth no more than $550,000. Their biggest error: they relied on financial numbers that were incomplete, vague, and in some cases downright inaccurate. Although Dolphin's Leap Marina is profitable today, with about $800,000 in annual revenues, the Karpinskis' experience provides a casebook lesson in how not to evaluate a possible purchase.
Karpinski admits that, despite her accounting-firm background, she was nave, largely because she was so eager to do a deal. "We were given a compilation on an accountant's letterhead," she explains. (A compilation is simply a list of sales and other business results, without any elaborative information such as footnotes or accountants' opinions about the reliability of the numbers. A more thorough analysis -- a limited financial review -- applies generally accepted accounting standards. A full audit includes tests of the accuracy of line items such as inventory.)
The couple was easily satisfied, though, since the compilation "showed the correct trends," Karpinski recalls. But she concedes that "we didn't realize that the categories on the list were much too general -- and that all kinds of numbers were combined to hide losses." Case in point: beer, bait, and tackle were listed on a single line, even though the margins and buying patterns for each were wildly different.
Also, the list of the marina's assets was inaccurate -- and what's more, the Karpinskis didn't receive the list until the close. That left them with no time to physically verify the accuracy of asset valuations, which the couple never considered doing in any case. "There were items that didn't even belong to the marina. They belonged to vendors," Karpinski says. Other items were overvalued. One painful example: a compressor valued at more than $1,000 was a hollow shell. Worse: the Karpinskis relied on a single appraisal, which had valued the marina on its sales potential, not on realities such as current sales.
Karpinski's advice to others? "Insist on at least a limited financial review and sit down with the company's accountant to make sure you understand every single line. If you can't talk to the accountant, don't do the deal."
She also urges that you "request a full list of assets prior to the closing and verify all important items. Make sure assets exist, that they don't belong to anyone else, that they work, and that they're worth what you're told they're worth." And she recommends obtaining at least two appraisals, reflecting more than one appraisal method.