As States Hunger For Revenues, A New Due Diligence Risk Confronts Sellers Of Businesses

Sellers of family owned businesses being purchased by private equity buyers find themselves subject to “quality of earnings studies.” These studies are detailed examinations of the components of the revenue that ultimately make up the EBITDA on which the business is valued. Recently, QoE studies have begun to focus on abandoned or unclaimed property issues.

Virtually every state requires resident businesses to file unclaimed property reports with the state’s department of finance and to pay the amount of unclaimed property that is reported. In effect, these payments are taxes, similar to franchise or state income taxes, except that they generally are not subject to statutes of limitation or regulated appeals processes. As a result, many states have come to look to unclaimed property as a reliable source of revenue. According to the National Association of Unclaimed Property Administrators (NAUPA), in FY 2015, state governments collected over $7.76 billion of unclaimed property, returning only $3.235 billion to rightful owners. The rest goes to the state treasuries.

In what situations are sellers at risk? Payments to vendors and others by checks that do not clear within a specified period of years are universally deemed unclaimed property. A small business an owner may simply void out the checks that do not clear. However in most states the check is unclaimed property and should be paid to the state. Credit memos and other credit balances issued to customers become unclaimed property if not applied within a specified period of time. The Council on State Taxation has identified those states that present the greatest risk for businesses with unclaimed property exposure. Not surprisingly, New York State is in the top quintile.

Working with Barton LLP early in the sale process to identify risks such as unclaimed property exposure can assist sellers in preserving the value of their businesses. Should you have questions on this or other related matters, please contact William A. Newman.