Thinking About Investing in a New Business Opportunity? Be Careful
David A. Schlein, CPA
Wednesday, August 30, 2017
If you're approached with a not-to-be-missed business opportunity, be sure you perform a close due diligence.
Although plenty of deals are legitimate, scammers often try to steal money from unsuspecting victims. In a recent example, 24 individuals were convicted of fraudulently selling vending machine businesses to investors. The sentences are being handed down on a piecemeal basis.
In the most recent sentence reported by the U.S. Department of Justice (DOJ), a 44-year-old New York sales representative was ordered to pay more than $546,487 in restitution and sentenced to 36 months in prison, followed by three years of supervised release.
The man "enticed people to pay $10,000 or more for a business that he promised would be prosperous, when he knew it was likely to fail," said Acting Assistant Attorney General Chad A. Readler, head of the DOJ's Civil Division.
How the Scam Unfolded
Through a vending machine company, the man sold fraudulent businesses with a promise to provide vending machines, candy, assistance in finding profitable locations, and continued customer support.
Although the company closed in July 2010, it continued to advertise in newspapers and on the Internet, offering ownership interests nationwide. Its sales representatives — with the knowledge and approval of the company's managers — misrepresented the business opportunity.
Specifically, the sales representatives provided false information about:
- Likely profits,
- The amount of money that previous investors were earning,
- How quickly buyers were likely to recover their investments,
- The quality of locations that were available, and
- The level of assistance investors would receive from locating companies recommended by the company.
The vending machine business referred buyers to locating companies that didn't find profitable locations and regularly changed their names to stay ahead of constant complaints. During the last five years the company was open, it generated more than $60 million in sales.
Investors did receive the vending machines, but little else, and most of them lost most or all of the money they spent on the scheme.
In earlier convictions reported by the DOJ, defendants were convicted of conspiracy, wire fraud and making false statements to federal agents. "These defendants promised their victims the American dream, but knew that what they in fact were offering was a worthless business opportunity," said Principal Deputy Assistant Attorney General Benjamin C. Mizer, head of the DOJ's Civil Division.
The Federal Trade Commission has established a Business Opportunity Rule that provides safeguards to ensure potential investors have all the information needed to evaluate whether a business opportunity is risky or not. The rule requires sellers to:
1. Identify themselves,
2. Disclose whether they make earnings claims and, if so, state the claim or claims in a separate statement attached to the basic disclosure document (see "What's in the Earnings Claim Statement?" below),
3. Disclose prior civil or criminal litigation involving claims of misrepresentation, fraud, securities law violations, or unfair or deceptive business practices that involve the business opportunity or its key personnel,
4. Outline any cancellation or refund policy, and
5. Furnish a list of references nearest to the potential 'buyer's location.
Furthermore, the disclosure document must be written in the language in which you and the seller discussed the opportunity. It must also notify you, as a prospective buyer, that your contact information will be available to other interested investors.
The disclosure document requires at least seven days of review before signing a contract or making a payment. Use this time judiciously. In particular, investigate references and look into seemingly outlandish claims. If you run into an inconsistency or a dubious claim, get out before it's too late.
What's in the Earnings Claim Statement?
The Federal Trade Commission requires sellers to include the following elements in earnings claims statements:
- The name of the person making the claim and the date,
- Specifics of the claim,
- The start and end date those earnings were achieved,
- The number and percentage of people who achieved those results or better,
- Any details about the individuals that may differ from your situation (for example, geographic locations), and
- A statement that you may obtain written proof of the seller's earning claims upon request.
Compare all of this information to the claims made by the seller. If things don't line up, the smartest thing you can do is to shut down the deal.
Protect Your Interests
What else can you do to protect yourself? Consider these practical suggestions:
- Carefully study the disclosure document, earnings claim statements and the proposed contract. Watch for potential loopholes that would benefit the seller and back away if the seller won't provide proof of earnings claims.
- Contact other current investors and ask tough questions.
- Have your advisors examine the paperwork and outline the risks.
- Check out the seller's history with a Google search and by contacting local agencies such as the Better Business Bureau. (Caveat: Just because there haven't been any complaints doesn't necessarily mean the seller is aboveboard.)
Sometimes, it will quickly become evident that the business opportunity is a scam. Other offers may require more in-depth analysis than the disclosure and earnings statements should provide.
If you suspect a business opportunity is fake, report it to the state attorney general's office, your county or state consumer protection agency and the Better Business Bureau. Also, you can file a complaint online with the Federal Trade Commission or call it at 1-877-FTC-HELP (1-877-382-4357).
This case is just one example of how you might be contacted about a "can't miss" business opportunity or see it advertised in a publication or online. The product or investment could be anything from a revolutionary soft drink for athletes to a foolproof method for "flipping" houses.
As the old saying goes, let the buyer beware. Research investment opportunities carefully and don't hesitate to ask your CPA for a second opinion.
For More Information
Dave is a tax partner with over 30 years’ experience in services to closely held family run businesses, high net worth individuals and for-profit flow through entities. Dave specializes in the areas of real estate investments, the oil and gas industry, partnerships, S corporations, and C corporations. His day-to-day activities include the coordination and delivery of tax planning and related compliance services.