What Does Due Diligence Cover When Buying a Business?

Due diligence when buying a business is the stretch between a signed letter of intent and a signed purchase agreement when the buyer gets to open every drawer. The goal is narrower than learning everything. You are trying to confirm that the business is what the seller described, find the problems that should change the price or the terms, and identify anything that would stop you from closing. Capitol Law Partners’ business transactions and M&A practice organizes diligence around those three outcomes, because a request list that does not tie back to a decision just produces a data room nobody reads.

Corporate records and ownership

Start with the entity itself. Request the articles or certificate of formation, bylaws or operating agreement, every amendment, minutes and written consents, and the stock ledger or membership interest schedule. You are confirming two things: that the people signing the deal actually own what they are selling, and that the company has the authority to sell it. A missing consent from a minority owner, an unexercised option, or a convertible note nobody mentioned can all surface here.

Check the company’s standing with the state where it was formed and every state where it is registered to do business. A company that has let its periodic filings lapse can usually be reinstated, but the buyer should know before closing, not after. Our post on the corporate records a small company must keep describes what a well-kept minute book looks like; many targets fall short, and the gap tells you something about how the business has been run.

Contracts, customers, and suppliers

Material contracts carry most of the value and most of the risk. Request every customer agreement above a reasonable threshold, every supplier and vendor agreement, leases, loan documents, licenses, and anything with a term longer than a year. Then read for four clauses: assignment, change of control, exclusivity or most-favored-customer terms, and termination rights.

Assignment and change-of-control clauses decide whether the contract survives the deal, and the answer differs between deal structures, as explained in our asset purchase vs stock purchase comparison. Customer concentration is a business question with legal consequences: if one customer is a third of revenue and its contract can be terminated on thirty days’ notice, the buyer will want that risk reflected in the price or in an earnout.

Intellectual property and data

Confirm the company owns what it claims to own. For trademarks and patents, pull the USPTO records and check that the registrant matches the selling entity, not a founder or a predecessor company. For software, copyrights, and know-how, the question is whether every employee and contractor who created it signed an invention assignment agreement. Contractor-developed code without a written assignment is a frequent finding, and it has to be cured before closing with a confirmatory assignment.

Data privacy belongs here too. Ask what personal data the business collects, where it is stored, which privacy laws apply, and whether there has been a breach. A seller’s representation that it complies with privacy law is only as good as the practices behind it.

Employees, benefits, and restrictive covenants

Request the employee census, offer letters, employment agreements, independent contractor agreements, the handbook, benefit plan documents, and any pending or threatened claims. Worker misclassification is the most common issue: long-term contractors who work like employees create back-tax and benefits exposure that the buyer inherits in a stock deal and may inherit in an asset deal under successor liability.

Review noncompete and nonsolicitation agreements with key people, and check whether they are enforceable where those people work. Several states restrict noncompetes, and the federal picture has moved more than once; our post on the FTC and noncompetes covers the background. If the value of the deal depends on three people staying, retention agreements negotiated before signing are safer than reliance on old covenants.

Financial, tax, litigation, and regulatory exposure

Legal diligence overlaps with the accountant’s quality-of-earnings work but asks different questions. On tax, request returns for the open years, sales tax filings in every state where the company has customers, payroll tax records, and any correspondence with the IRS or state agencies. Sales tax nexus is a common blind spot for companies that sell online. On debt, run UCC lien searches in the formation state and ask for payoff letters for anything that must be released at closing.

For litigation, request a schedule of pending, threatened, and concluded matters for the last several years, plus insurance policies and claims history. Then search court dockets independently. Sellers forget things; dockets do not.

Regulatory review depends on the industry. A restaurant has liquor and health permits; a government contractor has registrations and set-aside eligibility that may not survive a change in ownership; a healthcare business has licensure and billing compliance questions. Identify every license and permit the business needs to operate and confirm whether each one transfers, requires notice, or requires a new application. CLP’s risk management and legal compliance team often handles this slice of diligence because the same questions recur after closing.

What to do with the findings

Diligence findings land in one of four places. Some change the price. Some become specific indemnities, an escrow, or a closing condition in the purchase agreement. Some become pre-closing covenants: the seller must obtain the landlord’s consent, cure the IP assignment, or settle the claim before you close. And a few are deal-breakers that are better discovered now than litigated later. The buyer’s job is to sort every finding into one of those buckets before the purchase agreement is finalized, which is where the business and corporate law group’s transactional and compliance work meet.

If you are preparing to buy a business, a consultation with Capitol Law Partners can scope a diligence plan to the deal’s actual risks. Schedule a consultation.

This article is for informational purposes only and does not constitute legal advice. No attorney-client relationship is formed by this communication.

Attorney Cagatay Ersoy. Practical strategy for founders, investors, and growing companies.

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