Discover the high stakes of fraud allegations in M&A transactions through this case study involving overstated revenue and nondisclosure. When an IT consulting firm failed to disclose that its projected $25 million revenue was inflated due to enterprise division contributions, it led to a legal battle over the deferred purchase price and fraud claims. This post highlights the significant risks for sellers, including how transparency and accurate disclosures can prevent costly litigation and reputational damage. Read about the key lessons for M&A transactions, including the importance of truthful representations, indemnification caps, and the consequences of withholding critical information.
M&A Stories
January 17, 2025
Accusations of fraud in an M&A deal can lead to significant damages, which usually bypass the carefully negotiated indemnification cap. This case illustrates how overstated revenue—both in due diligence projections and contractual representations—can create fraud claims with substantial liability.
The seller, an information technology consulting firm specializing in Microsoft software, operated two divisions: one serving small and medium-sized businesses (SMBs) and another catering to enterprise clients. The buyer, a competitor in the same industry, sought to acquire the SMB division.
During due diligence in 2021, the buyer identified declining performance in the SMB division. To address these concerns, the seller provided a $25 million revenue forecast for the year, which became a key factor in the buyer’s decision to proceed. The buyer agreed to purchase the SMB division’s assets for $16.5 million—$8 million payable at closing on November 1, 2021, and $8.5 million due on April 30, 2022.
The asset purchase agreement included a representation and warranty that the SMB division had generated $25 million in revenue during the 12 months ending August 31, 2021. It also provided for a purchase price adjustment if the division’s revenue fell short of that figure.
To protect sensitive information, the seller blacked out customer names in the revenue forecasts shared during due diligence. Given the competitive relationship between the buyer and seller, this decision was reasonable. However, the blackout prevented the buyer from verifying whether the forecasted revenue came solely from SMB customers or if it included revenue from the enterprise division.
Before closing, the seller’s CEO discovered that a significant portion of the $25 million in revenue was tied to services provided to enterprise customers, not SMBs. Despite knowing this discrepancy, the seller failed to inform the buyer.
After closing, the buyer uncovered the issue and refused to pay the $8.5 million deferred portion of the purchase price, claiming the seller’s failure to disclose the source of the revenue constituted fraud. Litigation ensued in Delaware Superior Court, with the buyer alleging fraud and using the nondisclosure as a defense for withholding payment.
The seller, in turn, sued the buyer, its acquisition subsidiary, and its parent company for breach of contract. The seller sought damages for the deferred purchase price and attempted to dismiss the buyer’s fraud claims.
The Delaware Superior Court declined to grant summary judgment for the seller on its claims for the deferred purchase price or against the buyer’s fraud allegations, leaving the matter to trial.
While the seller’s blackout of customer names was reasonable given the competitive dynamic, its failure to disclose the revenue discrepancy was not. Correcting the revenue forecast before closing, though potentially reducing the purchase price or even derailing the deal—would have avoided accusations of fraud and the risk of significant damages that exceed the indemnification cap.
This case underscores the importance of accurate and transparent disclosures in M&A transactions. Sellers who knowingly withhold material information not only risk withheld payments but also protracted litigation, reputational damage, and liabilities far exceeding their negotiated protections.
See: Columbus US Inc. v. Enavate SMB, LLC, C.A. No. N22C-06-053, SKR CCLD, Superior Court of Delaware, (December 23, 2024).
Thank you for reading this blog. If you have any questions, insights, or if you’d like to engage in a more detailed discussion on this matter, I invite you to reach out directly.
Feel free to send me an email. I value thoughtful discussions and am always open to connecting with business owners, management, as well as professionals who share an interest in the complexities of M&A law.
By John McCauley: I write about recenegal problems of buyers and sellers of small businesses.
Email: jmccauley@mk-law.com
Profile: http://www.martindale.com/John-B-McCauley/176725-lawyer.htm
Telephone: 714 273-6291
Podcasts https://www.buzzsprout.com/2142689/12339043
Check out my books: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles and Selling Assets of a Small Business: Problems Taken From Recent Legal Battles
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