How to Buy a Business: Unreported Income

This is a common problem. The owner claims to have all this unreported income which he has trouble proving exists, but now he expects you to pay for it. There are a number of problems here for you as buyer. One, the seller is admitting to be a cheat. If he’s cheated the government to such an extent, he may well try to cheat you too. You assume a risk by entering into a business relationship with such a person. I say “relationship” because almost all business sales involve seller financing. This means you give the seller an IOU note for 75% of the price tag and commit to paying it off in 5 to 10 years. Furthermore, there are usually a number of contingencies built into the purchase agreement which will require ongoing reporting and communications between seller and buyer. Do you really want to be stuck for 5 to 10 years with someone you don’t trust?

Two, even if you believed him about the unreported income and decided to pay for it, there’s no guarantee that you will be able to replicate it. Chances are it came through collusion with another cheat. Once the seller is gone the foundation of trust that collusion was built upon, no longer exists and you may not be able to replicate it.

Finally, there are many businesses where this won’t be a huge issue because either the owner didn’t cheat (very much) or is realistic enough to know that he can’t expect the buyer to pay for something that can’t be proven.

So, if the seller insists that you pay for this phantom income, it’s best that you move onto the next deal.