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On Guard

Money-management strategies

Beware of strangers wanting to invest in your business. If the offer sounds too good to be true, it probably is, says James B. Hunt, national practice leader of investigative services for accounting firm Price Waterhouse LLP in Los Angeles.

Hunt cites two common scams entrepreneurs often fall prey to. In the first, called "bankruptcy bust-out," someone offers to buy your company using the note payable method, in which you hold a promissory note secured by common stock in the company. "The new owner abuses all the creditor relationships and runs credit and supplier accounts up to the limit," says Hunt. "They also clean out the cash in the company by paying out bonuses or advances to stockholders and shipping all inventory out of state to sell and convert into cash."

Finally, he or she declares bankruptcy, leaving you with a worthless promissory note. The scam can take as little as a couple of months to accomplish.

In the "advance fee" scam-prevalent in the high-tech industry-a growing company needing capital is approached by a money broker. The broker agrees to provide funding and draws up an official-looking document. But there are warning signs of a scam: Typically, no law firm is involved, and there is a joint escrow account with the broker controlling the escrow instructions. You are asked to pay an advance fee into the escrow account; when you do, the broker changes the escrow instruction to gain access to the money.

To avoid becoming a victim, do your due diligence, urges Hunt. "Know who you are doing business with," he says. "Investigate them, even if they're recommended by a friend or family member."

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This article was originally published in the January 1996 print edition of Entrepreneur with the headline: On Guard.

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