Acquiring a business is very different from starting one, and having an experienced business and corporate attorney involved from the outset can help you avoid costly surprises. When you buy an existing company, you are also buying its history, meaning its past contracts, its past compliance decisions, and in some cases its past problems. Thorough due diligence is what separates a buyer who understands exactly what they are acquiring from one who finds out the hard way after closing.
Every acquisition carries some risk that the business is not exactly what it appears to be on paper, and that risk falls squarely on the buyer once the deal closes. A seller who is eager to move forward will not always volunteer every issue that could affect your decision, not necessarily out of bad faith, but because they may not view certain items as material the way an outside buyer would. That gap in perspective is exactly what a disciplined diligence process, guided by an experienced business or corporate attorney, is designed to close.
Whether you are a first time buyer, a search fund, or a strategic acquirer expanding through acquisition, here is what a strong buy side diligence process should cover.
Buy Side Due Diligence; General
Buy side due diligence is the process of independently verifying everything a seller has represented about their business before you commit to closing. Rather than relying solely on the seller’s own summary of the company’s financial health, contracts, and legal standing, buy side due diligence puts the burden on you and your advisors to confirm those claims hold up under closer scrutiny. A thorough process touches several distinct areas, each of which can surface issues that affect your purchase price, your deal structure, or your decision to move forward with the acquisition at all.
Financial Diligence
Start with a clear picture of the target’s actual financial performance, not just the numbers presented in a pitch deck or confidential information memorandum. A quality of earnings analysis, typically performed by an accounting firm, adjusts reported earnings to reflect one time items, owner perks run through the business, and any accounting practices that inflate or understate true profitability. This is where many buyers discover that the EBITDA figure they were pitched does not hold up once adjustments are made.
Legal and Corporate Diligence
Confirm the target’s corporate structure is clean. Are all shares or membership interests properly issued and documented? Are there any disputes among owners? Is the entity in good standing in its state of formation and any states where it does business? You will also want a complete list of material contracts, with particular attention to change of control provisions that could require third party consent before your acquisition can close, and to any exclusivity or non-compete obligations the target has already agreed to that could restrict your plans post-acquisition.
Employment and Benefits Diligence
Review employment agreements, independent contractor arrangements, and benefit plans closely. Misclassification of workers as independent contractors is a common and costly issue that does not always surface until after closing, when the new owner inherits the liability. If key employees are essential to the business, consider whether you want new employment or retention agreements in place as a condition to closing.
Intellectual Property Diligence
If the value of the business depends significantly on its brand, technology, or proprietary processes, confirm that the target actually owns what it claims to own. This means checking trademark registrations, confirming assignment agreements exist for any IP developed by employees or contractors, and verifying there are no unresolved infringement claims or disputes over ownership.
Regulatory and Industry Specific Diligence
Depending on the industry, there may be licenses, permits, or regulatory approvals that do not automatically transfer with a change of ownership. This is especially true in heavily regulated industries such as cannabis, healthcare, and financial services, where a change of ownership can trigger a separate regulatory review or reapproval process that needs to be built into your closing timeline.
Structuring the Deal: Asset Purchase or Equity Purchase
As the buyer, your preferred deal structure will often differ from the seller’s. An asset purchase generally lets you select which liabilities you assume and gives you a stepped up tax basis in the acquired assets, which can mean larger depreciation deductions going forward. An equity purchase is often simpler from a contract assignment standpoint, since licenses, permits, and customer agreements typically transfer automatically with the entity, but it also means you are stepping into the target’s existing liabilities unless the purchase agreement carves those out. In some transactions involving an S corporation or a corporate subsidiary target, the parties can use a Section 338(h)(10) election to achieve a legal stock purchase while obtaining the tax treatment of an asset purchase, combining some of the benefits of both structures. Which approach makes sense depends heavily on the target’s liability profile, its contracts, and the tax positions of both sides.
Protecting Yourself in the Purchase Agreement
Diligence findings should translate directly into your purchase agreement. Representations and warranties should require the seller to stand behind statements about the business, indemnification provisions should allocate risk for anything that turns out to be inaccurate, and in some deals representations and warranties insurance can be used to shift some of that risk to a third party insurer rather than relying solely on the seller’s ability to pay a claim after closing.
The Bottom Line
Good acquisitions are built on good information. The buyers who avoid costly surprises are the ones who invest in thorough diligence upfront and use what they find to negotiate better protections in the deal itself, rather than assuming everything will work out once the deal is signed.
This blog is for informational purposes only and does not constitute legal advice. If you are evaluating an acquisition, contact Brown & Blaier, PC to discuss your specific transaction.