Most founders treat due diligence like a mathematical equation. Every dollar of bad inventory, every misclassified expense, must be wrangled into a perfect ledger. But what if the true cost of the deal isn't just on the balance sheet? Chris Farkas discovered that sometimes, paying a little extra in financial pain buys you invaluable goodwill.
Farkas acquired emergencykits.com, an e-commerce business selling emergency preparedness kits, about a year and a half ago. What started as an exciting opportunity quickly revealed a hidden layer of financial complexity that nearly derailed the entire transaction.
The Accounting Blind Spot That Hides Millions
Farkas quickly realized the seller's financials weren't just quirky; they were fundamentally miscategorized. “One of the biggest challenges that I ended up having throughout this transaction was that the owner was doing what I would call expense accounting rather than COGS accounting,” Farkas explains. Instead of accurately tracking Cost of Goods Sold (COGS), the seller expensed items immediately. This skewed everything. What was initially billed as a business doing around $850,000 in Seller's Discretionary Earnings (SDE) began to unravel under Farkas's scrutiny. He simply “didn't really believe that to be the case at the time,” and his deep dive proved it wasn't. This isn't just an accounting technicality; it’s a smokescreen that can inflate SDE estimates by hundreds of thousands of dollars, fundamentally altering valuation.
Digging further, Farkas uncovered substantial aged and obsolete inventory. These weren't just numbers on a spreadsheet; they represented physical space, carrying costs, and dead capital. For a buyer with an operational background like Farkas, this was a clear red flag. He relied on his own expertise for deep financial analysis and brought in a firm for a quick audit, specifically to ensure there were no "shenanigans" beyond the messy accounting.
The Goodwill Price Tag
The due diligence process dragged on for five months. Farkas was on the precipice of closing, but the inventory issue and accounting discrepancies created immense tension. He faced a critical choice: push relentlessly for every dollar of discount on the bad inventory, or make a concession to preserve the relationship with the seller. He knew he needed the seller's cooperation post-acquisition for a smooth transition. “You're on the precipice and the question is like do you how hard do you push, right? Because one of the important things here is that if I buy the business on the other side of the purchase I need a seller who's actually going to be in like good natured about transitioning the business to him,” Farkas reflected.
Ultimately, Farkas made a calculated decision: he accepted more bad inventory than he truly wanted. “I think I ate more of it than I really wanted to,” he admits, explaining that much of it will simply be jettisoned when they move to a new building in October. This wasn't a financial win, but it was a strategic one. As podcast host Will Smith observed, what Farkas thought he might be paying for in goodwill with the seller, he got. That spirit of cooperation proved invaluable during the tough post-acquisition period.