A bad deal that kept getting worse
This is story is of a recent due diligence investigation of a proposed
acquisition. The client intended to acquire the company and hire its owner.
The owner was an experienced inventor of automatic weapons technology,
and the company was a manufacturer of automatic weapons components to
be sold to other companies that would integrate these products into there
The key assets of the company were the 13 patents filed both domestically
and internationally on the technology for weapon components. The second
key asset of the company was the owner himself. The owner is important
because, while patents describe the science behind a technology, they rarely
describe the art of making the technology work.
The due diligence process began with specially formatted questionnaires.
The questionnaires used for this investigation were a corporate questionnaire
and a key-individual questionnaire. Every officer, director, and key person in
the company received a key-individual questionnaire.
When the completed questionnaires were received back they were late, not
prepared in accordance with their instructions and incomplete. This is a red
flag. If someone selling a business for $750,000 and cannot take the time to
complete a five page questionnaire accurately and completely, there is
usually something wrong.
Several claims were made by the selling individual. These claims related to the
patents, capital equipment of the company, and the ability and skill of the individual.
An investigation of the patents with the U.S. Patent and Trademark Office
showed that the Patents were null, void, and now public domain: There is an
annual maintenance fee required to keep the patents in force. The
maintenance fee had not been paid for many years on any of the patents.
An investigation of the principal showed that he was a convicted felon. He
was convicted on a federal government contracting billing scheme where he
over-billed on products and services. (It gets better) During the entire time
he was operating the company he was trying to sell – he was on a prison
work release program! This was a result of his government contract billing
scheme conviction. He could work at the company during the day but had to
go back to prison at night and on weekends. Also, as a convicted felon, he
could not be anywhere near a firearm of any sort whatsoever let alone own a
factory that produced components for firearms. (It gets even better)
On investigating the company it was found that the owner did not own the
company. It was set up in the name of relatives who were acting as his
nominees. It seems the federal government wanted its money back, and he
was under a requirement to pay restitution and damages of almost $400,000.
This restitution this would put a substantial dent into the money coming
from the sale of his company.
To add insult to injury, it appears that he had sold or licensed the patents to
several other companies. Two of these companies had recently filed civil
racketeering suits against the individual and the listed owners of the company.
When his relatives learned that they were being sued for civil racketeering
because of their entrepreneurial relative, you could practically hear their
screams from coast to coast even without a telephone.
Suffice it to say the client passed on the company. The due diligence
investigation occurred near the end of the transaction. The acquisition
documents had been drawn up and the accountants had reviewed the books.
The books were good. The company’s sales and client base were accurately
stated. But it was a mess beyond belief.
Approximately $15,000 had been spent on attorney and accounting fees. The
due diligence investigation cost less than $2,000. Had the transaction been
completed, the liability incurred by the accountants and the attorneys could
have been substantial. The loss to the client could have been corporately fatal.
For their own protection, the owner’s relatives notified all authorities and
regulatory agencies of the real nature of his activities. As a result, three
months after the client passed on the acquisition opportunity the Bureau of
Alcohol Tobacco and Firearms closed down the plant and caused the
owner’s parole to be revoked.