Buying an Existing Business? The Due Diligence Mistakes That Cost Buyers Thousands

Acquiring an existing business may seem like a short-cut to success – an already established customer base, cash flow and an established infrastructure. Most customers dwell on revenue figures and tangible assets. Legal exposure and buried liabilities, however, are in many cases the same things that cost buyers tens or even hundreds of thousands after they settle. These are the pitfalls that can be avoided, provided you know what to look at and where buyers usually do fall short. 

Due diligence is the best protection you have before you put your signature on the dotted line. It is about making sure that what you believe you are purchasing is exactly what you are buying. And that, very frequently, involves the assistance of a professional Buying Business Lawyer and, in certain instances, even Criminal Lawyers in case of a fraud risk.

Why Legal Due Diligence Matters – Beyond the Numbers

A lot of buyers assume that due diligence is simply a matter of considering financial performances and projections. As much as it is essential to know about the profitability and cash flow, legal due diligence is far more intricate. It reveals the risks that you are going to have merely by putting yourself in the shoes of the seller.

According to the Queensland government’s advice on the concept of buying a business, due diligence is a process that requires one to review contracts, expenses, legal structure, compliance records, leases, tax history and supplier agreements first before any binding decision is made.

By not doing so, you expose yourself to the liabilities that exist, unreported conflicts and contractual pitfalls that might have an impact on profitability, business or even your capacity to own and operate the business in the manner you would have normally.

Common Due Diligence Gaps That Cost Buyers

Even experienced purchasers frequently overlook certain areas, and it’s those oversights that lead to costly surprises later.

Supplier Contracts and Commercial Agreements

Many businesses are dependent on supplier and customer contracts. However, contracts do not necessarily assign a change of ownership. There are change of control clauses in some of the agreements, which require third-party consent, or may permit termination on sale. The absence of these details can bring an immediate derailment to supply, revenues and operations.

In fact, any significant contracts with the suppliers, customers, landlords or partners should be subject to a thorough due diligence exercise to determine possible risk, such as unassigned contracts or onerous obligations.

Compliance History and Regulatory Risks

A company may look profitable and compliant until you investigate its legal records. Licences could be out of date, industry-specific permits were not transferable and environmental or safety compliance could be deficient. Some companies have even been operating illegally under the laws they should have been operating under; that is, you may end up paying the fines and clean-up after paying the settlement.

When conducting due diligence, a good review of compliance checks for licences, permits, safety records and regulatory adherence is a critical aspect.

Undisclosed Liabilities and Historical Issues

Hidden liabilities – unpaid tax, litigation risk, employee claims, lease issues or contingent liabilities are some examples that come into light once settled, unless discovered. Unless the right warranties, indemnities or modifications are negotiated, buyers can be responsible for these obligations once the deal has been closed.

Legal due diligence assists in unravelling probable liabilities to either procure safeguards in the purchase deal or retreat ahead of time.

Financial Consequences of Missed Due Diligence

The true cost of skipping or rushing due diligence may not be apparent on the surface. A business might have attractive revenue figures now, but:

• Supplier prices may spike post-sale because contracts weren’t assigned or negotiated.
• Customers might depart if key service agreements are non-transferable.
• Regulatory breaches can trigger fines, operational suspensions or forced compliance work;
• Leases may expire or become unenforceable, threatening your premises.

Indicatively, there are times when buyers will find that the stock they were buying during a sale is not part of the business per se, and they will suffer huge replacement expenses during settlement. Such a problem is the general outcome of not having the stock ownership and asset lists, which are not checked independently prior to purchasing.

Such financial consequences can often overshadow any discounts on the purchase price that may have been missed so easily, so what appeared to be a good deal will have become a huge loss.

The Role of Professionals in Mitigating Risk

Due diligence is not a task that can be comfortably carried out by an individual. Experts have an invaluable perspective and technical expertise that can be applied to the process.

Buying Business Lawyers

An experienced business purchase lawyer helps you make sense of the legal documents that contain a lot of hidden contract risks, as well as to formulate the sale agreement in a way that best protects your interests. Lawyers audit agreements and company books to ensure that you are not surprised in the future.

The protective clauses that a good lawyer can assist in include warranties, indemnities and conditions precedent. These offer a legal solution in case of problems arising following the settlement.

Criminal Lawyers (Where Relevant)

Criminal Lawyers are not involved in all transactions, but this does not mean that there are no instances in which they are applicable. In case there are indications of fraud, e.g. intentional misrepresentation of financials or falsification of records, you may want to seek the opinion of a criminal law adviser to determine what your rights and remedies may be. This gives a certain degree of protection in case you discover deliberate malpractices during or after due diligence.

Practical Steps to Avoid Costly Mistakes

Doing due diligence thoroughly requires a structured process:

• Begin with a detailed checklist, which covers financials, licences and compliance records, supplier and customer contracts, intellectual property, leases, employee obligations and insurance.
• Include clauses in the sale contract that would enable you to cancel the deal or renegotiate the price in case any major problems are identified. It is the reason why many contracts have issued a due diligence period.
• Discuss liability limits and warranties with your attorneys. Buyers are also in a position of leverage in case they discover liabilities that have a substantive impact on the business value or operations.
• Most importantly, do not consider due diligence as a box-ticking process; it is about knowing what you are purchasing both legally and operationally and making sure you are not committing yourself to a financial liability in the future.

FAQs

What is due diligence when buying a business?

Due diligence is the process of thoroughly investigating a business before purchase to confirm financial health, legal compliance and potential liabilities, ensuring you make an informed decision. 

What happens if supplier contracts aren’t properly reviewed?

If supplier agreements contain clauses that aren’t assignable or require consent, you could lose key supply relationships after settlement, causing operational disruption and increased costs.

Can due diligence uncover undisclosed legal risks?

Yes, detailed due diligence can reveal hidden liabilities such as unpaid taxes, unresolved litigation, licence issues or staff entitlement backlogs that sellers did not disclose. 

When should legal support be involved?

Legal support should be engaged early before signing a contract, so Buying Business Lawyers can advise on contractual risks, compliance issues and negotiate protective terms.

Is it worth walking away if due diligence uncovers problems?

Often yes. If core aspects like financials, compliance or contracts are fundamentally flawed, walking away before settlement can save significant money and stress in the long run.