Summary
Explains that business due diligence involves three distinct reviews (legal, financial, and tax) and what each one can miss on its own. Uses a labeled composite example of a worker-classification risk, describes what excited buyers tend to skip, and notes OCL assists both buyers and sellers, with an FAQ on timing, seller trust, and what happens when a problem surfaces.
By: Jordan Gerheim, CEO – Outside Chief Legal LLC
Buying a business is exciting. That is exactly the problem.
Jordan Gerheim, founder of Outside Chief Legal, explains it this way: “We represent sellers of businesses, but we also represent buyers. You want to make sure that business is what it is represented to be. The legal due diligence, the financial due diligence, the tax due diligence, we can help with all of that.”
That statement has three words doing a great deal of work: legal, financial, and tax. Many buyers treat business due diligence as one task with a checklist. It is not. It involves three distinct reviews, handled through different disciplines, each designed to identify issues the other two may not reveal.
TL;DR: Business due diligence has three distinct lenses: legal, which evaluates what you are acquiring and what obligations may be connected to it; financial, which assesses whether the reported numbers are accurate and sustainable; and tax, which evaluates potential tax liability and the tax consequences of the transaction going forward. A deal can pass two of those reviews and still be the wrong deal. Buyers who are excited about an opportunity are often the most likely to rush the review that could have identified the problem.
What business due diligence covers
When people say “do your due diligence,” they often mean review the financial statements and avoid relying on incomplete information. That is a start, but it leaves two important categories unexamined.
Legal due diligence asks: What are you actually buying, and what comes with it? This can include contracts, leases, employment agreements, pending or threatened litigation, intellectual-property ownership, licenses and permits, corporate structure, and entity good standing. It is where a buyer may learn that a supposedly transferable lease requires consent, or that a key customer contract contains a change-of-control provision allowing the customer to terminate after an ownership change.
Financial due diligence asks: Are the numbers what they appear to be? It goes beyond the tax return and the profit-and-loss statement provided by the seller. It can involve verifying revenue against bank deposits, reviewing accounts receivable to distinguish collectible balances from amounts with a low likelihood of collection, and identifying whether reported earnings depend on one-time events that will not repeat after closing.
Tax due diligence asks: What tax exposure may be associated with the entity, and what changes when you become the owner? This review can include unpaid payroll taxes, sales-tax exposure, unresolved audits, and the structural question of whether the transaction is an asset purchase or an entity purchase. That structure can materially affect the liabilities assumed, retained, or potentially imposed under applicable law. Tax due diligence may be the least glamorous of the three reviews, and it is often the one shortened when a deal is moving quickly.
What each review can miss
A financial review can confirm that revenue is real and margins are accurate, yet still miss that the business’s principal customer contract can be terminated on 30 days’ notice without cause. That is a legal due-diligence issue.
A legal review can confirm that the entity is in good standing and that the contracts appear sound, yet still miss that a portion of trailing-twelve-month revenue came from a related-party transaction that will not continue under new ownership. That is a financial due-diligence issue.
Both reviews can come back clean, while the buyer still faces potential payroll-tax or sales-tax exposure based on the company’s prior practices, the transaction structure, or applicable law. That is a tax due-diligence issue. Buyers sometimes assume that “the accountant already reviewed it,” when the accountant may have been reviewing financial performance rather than potential tax liability.
A deal that looked fine and was not
Consider a buyer evaluating a well-run service business. The company has strong reviews, steady clients, and a seller who appears straightforward. The financials check out: reported revenue matches deposits, and margins are consistent with the industry. The legal review is also quiet: there is no pending litigation, and the principal contracts appear standard.
The concern arises on the tax side. For years, the business has treated certain workers as independent contractors. Based on the facts and applicable law, that classification may not hold up. The potential exposure may not appear on a financial statement because misclassified workers do not necessarily create a recorded liability until an agency review, claim, or dispute raises the issue. That may happen years later, including after a change in ownership.
This issue was not missed by accident. Tax due diligence is designed to ask the worker-classification question. A buyer who skips that review, or treats it as a formality because the numbers “look fine,” may close on a business with a risk that has not yet appeared in the records.
This is a composite example intended to illustrate a recurring risk pattern. It is not an account of a specific OCL matter or client.
What excited buyers tend to skip
Excited buyers often shorten the tax review first because it is less visible and the deal already feels financially sound. They may accept a seller’s representation as verification, even though a seller’s statement that a contract is transferable is not the same as reviewing the transfer provision and obtaining any required consent.
They may also treat legal review as a formality after the financials look good, even though each review is testing a different part of the transaction. Finally, buyers can allow timeline pressure to compress the review period, particularly when a seller presents a fast closing as part of the opportunity.
Buyer-side, not just seller-side
OCL assists clients on both sides of business acquisitions. On the seller side, that often involves preparing a business for a clean and well-supported sale. On the buyer side, it means coordinating legal, financial, and tax due diligence as connected but distinct reviews, so the buyer understands what is being acquired before closing rather than after.
If you are considering the purchase of a business, or you are already several conversations into a deal that feels right, a Risk-Free Strategy Session offers a practical, low-pressure opportunity to obtain a second perspective before you are locked into the transaction.
General information only. This article is not legal or tax advice.
FAQ
What is the difference between legal, financial, and tax due diligence?
Legal due diligence evaluates what you are acquiring and the obligations connected to it. Financial due diligence evaluates whether reported numbers are accurate, supported, and repeatable. Tax due diligence evaluates potential tax exposure, tax compliance, and the consequences of the proposed transaction structure.
Can business due diligence be completed quickly?
It can move more efficiently when records are organized and the seller is responsive. However, shortening the process too aggressively can result in incomplete review, particularly of tax issues.
Should I complete due diligence even if the seller seems trustworthy?
Yes. A seller can be honest about what they know and still be unaware of an exposure that has not yet surfaced. Due diligence protects both the buyer and the transaction by verifying key information independently.
Does OCL represent buyers, sellers, or both in a business acquisition?
OCL represents both buyers and sellers, depending on the engagement and the firm’s ability to do so without a conflict of interest.
What happens if due diligence identifies a problem?
A finding does not automatically end the deal. Depending on the issue, it may affect the purchase price, transaction structure, representations and warranties, indemnification terms, closing conditions, or the decision to proceed.
General information only. This article is not legal advice.
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Outside Chief Legal LLC is a modern, forward-thinking law firm serving as fractional chief legal officers and outside general counsel for businesses and their owners. With over 200 years of combined litigation, in-house, general counsel, and administrative legal experience, the firm delivers approachable, comprehensive counsel that blends legal expertise with practical business insight to help clients navigate ownership complexities with confidence. OCL is a trusted partner for founders, business owners, and leadership teams nationwide. Learn more about our firm, meet our team, or schedule a Risk-Free Strategy Session to talk with an attorney about how we can help your company.
