Buying a business is a risky endeavour, however, it becomes even riskier if you go into the business ‘blind’ without having done thorough due diligence.
Due diligence is perhaps the most essential element to any successful commercial transaction. It is important to not only assess the value of the business, but also confirm any facts the seller has provided, and determine any potential anomalies, risks or unforeseen liabilities.
Buying a business on nothing more than your own evaluation is an accident waiting to happen. As a buyer, it is essential to consider that everything is not always as it seems, which is exactly what one businessman had to learn – the hard way.
The case of Lum v Chan
In the case of Lum v Chan, Mr Lum purchased the trading stock, equipment and other assets of Chan’s catering supplies and equipment company for a total sum of £100,000 in 2014. Lum had high hopes for the business’ future, aiming to expand and work with other businesses overseas. For the sake of carrying out some form of ‘due diligence’, Lum decided to work for Chan’s business in order to gain an understanding of just how it worked.
However, by 2016, Lum’s dreams were dashed when his new business went into liquidation. How? Lum hired Chan, the previous owner, as his new manager, but this business arrangement quickly turned out to be a recipe for disaster. Despite Chan’s duty of fidelity, he was found to be diverting payments to his own private bank account, alongside the account of the previous company. Additionally, Chan was found to be diverting business opportunities, and as a result, Chan was able to revive his previous business.
The absence of conventional due diligence
Lum took Chan to court and was able to recover some damages for losses caused by Chan’s actions but the outcome was far from satisfactory. The court had a difficult task in front of them – Lum relied on his own understanding and belief of the business’ true value and workload, having worked for the previous company but the court had difficulty in assessing the actual value due to the new company’s lack of financial accounts and the inaccurate accounts held by the previous company.
Consequently, the main problem in this case was the absence of any conventional due diligence which made accurate quantification of Lum’s claim extremely difficult. Had Lum insisted on properly reviewing the company’s accounts before he bought the business, he would have been in a better position in understanding the value and therefore calculating any losses.
If you’re considering buying a business
Before buying a business, you should always consider how much you actually know about it. It is important to have an accurate understanding, and this can be done with the right advisors by your side.
At 2020 Business Law, we have helped business owners through this process. If you have plans for buying a business in the future, talk to us. We can help you right from the start to make sure this is the right investment for you.
Contact the team by email email@example.com or call 01980 676875.