Dispute Resolution · Buyer's Guide
The Numbers Were Wrong: First Steps After Buying a Business
Months after closing, revenue is lower than the seller's statements showed, or margins never match. What a buyer does in the next few weeks often matters as much as what the seller did. This guide sets out a practical sequence.
Recognizing the problem
How misstated financials usually come to light
Buyers rarely find a single smoking gun. More often, the business simply fails to perform the way its historical numbers said it should, and the explanation emerges from the books.
Typical discoveries include revenue booked before it was earned, a large customer whose orders were pulled forward to dress up the final year, personal expenses that were added back too generously, payables left unrecorded, inventory counted at values it never had, or cash sales that appeared in the seller's presentation but not in the bank statements. Sometimes the cause is honest error or aggressive but disclosed accounting; sometimes it is deliberate.
At this stage you do not need to decide which. You need to protect your ability to prove what happened and to use the remedies in your purchase agreement. The steps below are designed to do that without escalating prematurely.
What to do now
Six first steps, in order
Most buyers want to call the seller immediately. A short delay to get organized is usually wiser.
Hold off on confronting the seller
An angry call can prompt deletions, rehearsed explanations or a race to the courthouse. Gather facts first; communications can then be deliberate and in writing.
Preserve every record
Lock down the accounting system, bank access, point-of-sale data, emails and the data room or diligence files you received. Do not alter historical entries while investigating; make copies instead.
Bring in counsel, then an accountant
A forensic accountant engaged through your lawyer can reconcile the seller's statements to bank deposits and tax returns, with a better chance of keeping the work confidential while the dispute develops.
Review the representations
Find the financial-statements representation and related provisions, the disclosure schedules, and the definitions they rely on. The claim lives in that language.
Calendar the deadlines
Identify the survival period for the financial representations, any notice period after discovery, and the general limitation period. Missing a contractual deadline can forfeit a valid claim.
Give the right notice
Once the basis is clear, send the notice the agreement requires, to the right people and escrow agent, in the required form. This starts the contractual claims process.
Where to look in the purchase agreement
Provisions that usually cover financial misstatements
Few agreements use the word misrepresentation. These are the clauses that typically do the work.
Financial statements
Often a promise that the statements were prepared from the books and fairly present the results for the periods covered, sometimes tied to a stated accounting basis applied consistently.
Undisclosed liabilities
A statement that there are no liabilities beyond those shown or scheduled. Unrecorded payables and accrued obligations often fall here.
Undisclosed liabilitiesAbsence of changes
A representation that nothing material changed between the last statements and closing, relevant when results deteriorated just before the sale.
Receivables and inventory
Promises that receivables are collectible and inventory is usable and saleable, frequently with specific measurement rules.
Taxes
Representations that returns were filed accurately, plus specific tax indemnities that may survive longer than general warranties.
Books and records
A promise that records are complete and accurate, useful where the problem is the seller's bookkeeping rather than a single number.
Measuring the harm
Ways buyers and sellers argue about the size of the loss
The measure of loss is often the most contested part of a financial-misstatement dispute, and it depends on the agreement and the legal theory.
| Approach | The buyer's argument | The seller's usual response |
|---|---|---|
| Overpayment based on price multiple | The price was a multiple of earnings, so each overstated dollar of earnings inflated the price by the multiple | The multiple was negotiated on many factors; the agreement may exclude diminution-in-value losses |
| Specific costs | Actual amounts spent to pay unrecorded liabilities or correct the problem | Some costs were disclosed, below the basket or would have arisen anyway |
| Lost profits | The business cannot earn what was represented going forward | Speculative, excluded by a consequential-damages waiver, or caused by the buyer's management |
| Purchase price adjustment | The closing statement used wrong figures and must be trued up | The adjustment period has closed or the dispute belongs with the independent accountant |
Which measures are available depends heavily on the agreement and on whether the claim is pursued as an indemnity, a warranty breach or fraud; the differences between those theories are explained on the firm's page on fraud and warranty claims after an acquisition.
A common temptation
Withholding payments on the seller note
Buyers who owe the seller money under a note or earnout often want to stop paying. Sometimes the agreement expressly allows set-off against amounts owed to the seller; often it limits set-off to claims that are finally determined or follows a specific procedure. Withholding without that right can put the buyer in default, accelerate the note and hand the seller a claim of its own.
Before withholding anything, have the set-off and default provisions reviewed. If set-off is available, use it exactly as the agreement describes and say so in writing. Disputes that cannot be resolved by negotiation move into the forum the agreement names, within the firm's business dispute resolution services, and the contractual mechanics of making the claim are covered under indemnification claims after closing.
Questions & answers
Questions from buyers who found the numbers were off
What should I do first if I think the seller inflated the numbers?
Preserve the records and get advice before contacting the seller. Secure the accounting files, bank data and every document from diligence, and note the date you first noticed the problem. Then have the purchase agreement reviewed for the relevant representations, deadlines and notice requirements, so that your first communication with the seller protects your claim rather than weakening it.
Should I stop paying the seller note?
Not without reviewing the agreement. Some purchase agreements permit set-off against the note for indemnification claims, often only after a set procedure or a final determination. Others do not. Stopping payments without a contractual right can be a default that accelerates the debt and gives the seller leverage, even if your underlying complaint is valid.
How is the loss measured when earnings were overstated?
There is no single formula. Buyers often argue that the price was set as a multiple of earnings, so the overstatement inflated the price accordingly. Sellers respond that the agreement excludes that measure or that other factors drove the price. Specific out-of-pocket costs are usually easier to recover. The agreement's definition of losses frequently decides the debate.
Do I need a forensic accountant?
Usually, if the amounts are significant. A forensic accountant can trace reported revenue to deposits, test add-backs and identify where the seller's figures departed from the underlying records. Engaging the accountant through counsel helps organize the work around the legal claims and may help protect its confidentiality while the dispute is ongoing.
Your attorney
Paul H. Appel, Esq.
Every matter at the firm is handled personally by Paul — the same attorney reads the documents, gives the advice and negotiates on your behalf.
- Education
- Columbia Law School, Juris Doctor (1967)
- Experience
- 58+ years in commercial and business law
- Focus for this matter
- Negotiated resolution, mediation and arbitration of business disputes
- Office
- Freehold, NJ — serving Monmouth, Middlesex & Ocean Counties
Contact
Discuss Your Business Matter With Paul
Describe what the business is dealing with — a contract on your desk, a deal in progress, a dispute or a company you are about to form. You will hear back from the attorney who handles the work.
- Phone917-748-6124
- Office11 Crestwood Drive, Freehold, NJ 07728
- ConsultationsBy phone, video or in person by appointment
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