DUE DILIGENCE

The most important aspect of buying a shell is performing your due diligence. If you have retained a savvy business consultant he will comb through all of the previous filings of the shell under consideration. He will be able to identify who are the major shareholders, the number of authorized and outstanding common and preferred shares along with the number of shareholders. Are there any outstanding warrants or options that could be exercised after you have purchased the shell? Your attorney will then review the business consultant’s findings to determine if you should consider moving forward with the transaction.

Additionally, your business consultant can determine the outstanding liabilities of the shell. Sometimes, a shell has so much debt that you can’t possibly buy it because the purchase price does not cover the outstanding liabilities. There are many companies that have had to file for Chapter 11 or Chapter 7 bankruptcy to be able to eliminate their previous liabilities. If you decide to buy a shell that has come out of bankruptcy make sure you have an experienced SEC attorney handle the entire transaction. The last thing you want is to buy a shell and find out you are now responsible for the liabilities of the past owner.

I have a great true story that illustrates what happens when you buy a bankrupt business without performing your proper due diligence. I am sure you have heard of Jim McCann. Jim is the guy who acquired the 1-800-FLOWERS number in 1986 after successfully building his own chain of 14 flower shops in the New York metropolitan area. Jim heard that 1-800-Flowers had recently filed for bankruptcy protection so he flew out to Dallas to meet with the company. Jim, being affable person that he is, didn’t need those investment bankers or lawyers. He reasoned, why spend all of that extra money? So Jim bought the company for $2,000,000. A hell of a deal, right? Wrong! You see instead of buying “certain assets” of the company Jim bought the entire company, therefore becoming responsible for all of its past debt and liabilities. In the next six months Jim discovered he now owed an additional $7,000,000 of debt from his purchase of 1-800-FlOWERS. As Jim tells it, he was sitting and having a discussion with his Irish mother about filing for bankruptcy protection. Jim’s mother looked him straight in the eye and said “we don’t do that”. So Jim did the honorable thing and struggled through this nightmare for the next six years and eventually paid off the entire debt.

Moral to the story. Don’t be pennywise and dollar foolish. Make sure you retain professional advisors when you are spending substantial amounts of money on anything, especially when it comes to buying a shell.

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