Buying a business is one of the most significant financial decisions a person can make. You’ve found a business that looks right — the revenue is there, the owner is motivated to sell, and you can already picture yourself running it. The excitement is real.
So is the risk.
In our M&A practice at BMBR, we’ve worked with buyers at every stage of the acquisition process. The deals that go sideways — the ones where buyers find themselves dealing with unexpected lawsuits, tax bills, or employee disputes six months after closing — almost always trace back to the same set of overlooked issues during due diligence.
Here are the five things buyers most commonly miss, and why they matter.
Why Due Diligence Gaps Are So Expensive
Due diligence is the process of thoroughly reviewing a business before you buy it. It covers finances, legal obligations, operations, employees, intellectual property, and more. Most buyers do some version of it. But “some version” is often not enough.
The hard dollar cost of even a modest dispute arising from a missed due diligence item — a contract you didn’t read closely, a liability you didn’t know existed — can easily run $50,000 to $150,000 or more in legal fees alone, before any settlement or judgment. That doesn’t include the operational disruption, the distraction from running your new business, or the damage to relationships with employees and customers.
The good news: most of these problems are preventable. The bad news: they require deliberate attention before the deal closes, not after.
#1 — They Don’t Look Closely Enough at Contracts
Every business runs on contracts — vendor agreements, customer agreements, leases, service contracts, software licenses. Buyers typically review a list of these agreements. What they often don’t do is read them carefully.
The details matter enormously. Does a key vendor contract have a change-of-control clause that allows the vendor to terminate or renegotiate if the business is sold? Does your commercial lease require landlord consent to assign it to a new owner — and what are the conditions? Is a major customer on a month-to-month agreement that they could walk away from the day after you close?
Any one of these issues can materially change the value of what you’re buying.
Practice Tip: Don’t just collect contracts — review assignment provisions, termination rights, and auto-renewal clauses in every agreement that materially affects the business. Pay particular attention to leases and any agreements with customers representing more than 10% of revenue.
#2 — They Overlook Employee and Contractor Classifications
California has some of the strictest employment laws in the country. Before you buy a business, you need to understand exactly who works there — and how they’re classified.
If the business has been misclassifying workers as independent contractors when they should be employees under California’s ABC test (established by AB 5), you may be inheriting significant liability. Penalties under California law for misclassification can include back wages, unpaid payroll taxes, interest, and civil penalties that add up quickly — often $5,000 to $25,000 per misclassified worker, or more depending on the duration.
You should also review whether the business is current on wage and hour compliance. Unpaid overtime, missed meal and rest break premiums, and inaccurate wage statements are among the most common sources of employment litigation in California, and employees have up to three years to bring certain wage claims.
Practice Tip: Request payroll records, contractor agreements, and any prior wage and hour audits or complaints as part of due diligence. If the business has a large contractor workforce, this warrants specific legal review before you close.
#3 — They Underestimate Pending or Hidden Liabilities
Buyers often focus on what a business owns. They should spend equal time on what a business owes — or might owe.
Hidden liabilities can take many forms. There may be outstanding litigation or threatened claims that haven’t been formally filed. There may be unpaid sales tax obligations, outstanding payroll tax deposits, or state and local assessments. There may be environmental obligations tied to the property or operations. There may be vendor disputes or unresolved customer refund demands.
In an asset purchase — the most common structure for small business acquisitions — you can often limit your exposure to successor liability by carefully structuring what you are and are not acquiring. But this only works if you know what you’re structuring around. Undisclosed liabilities you discover after closing are a different, and much harder, problem.
Practice Tip: Always request a representation and warranty from the seller disclosing all known claims, litigation, and regulatory proceedings. Have your attorney conduct lien searches and review public records for judgments, tax liens, and UCC filings before closing.
#4 — They Assume the Seller’s Financials Tell the Whole Story
Financial statements are essential. They are not sufficient.
Sellers present their businesses in the best possible light. That is not necessarily dishonest — it’s human nature. But it means buyers need to look past the top-line numbers and understand what’s driving them.
A few things to watch for: Is revenue concentrated in one or two customers, creating a dependency risk? Are the owner’s personal expenses running through the business in ways that inflate profit margins that won’t survive under your ownership? Has the seller deferred maintenance, capital expenditures, or staffing in ways that will require immediate investment after you take over? Are accounts receivable aging in ways that suggest collectability problems?
Normalized, adjusted financials — often called “seller’s discretionary earnings” or SDE — are commonly used in small business transactions. Make sure you and your advisors understand the adjustments being made and whether they are reasonable.
#5 — They Don’t Plan for the Transition Period
This one is less about due diligence and more about deal structure — and it can be just as costly.
When you buy a business, especially a service-based one, you are often buying relationships as much as assets. The seller may be the face of the business to key customers, vendors, and employees. If the seller walks out the door on the day of closing with a check, those relationships walk out too.
A well-structured acquisition includes provisions for transition: a seller consulting or employment agreement that keeps the owner engaged for a defined period, non-solicitation and non-competition agreements that comply with California law (which restricts non-competes significantly under Business and Professions Code Section 16600), and a communication plan for introducing the new owner to key stakeholders.
We’ve seen buyers lose customers worth hundreds of thousands of dollars in annual revenue because there was no transition plan. Don’t let the excitement of closing blind you to what happens the day after.
Key Takeaways
- Review every contract for assignment and termination provisions — not just whether the contract exists.
- Audit employee and contractor classifications before closing; California’s AB 5 creates real exposure for misclassification.
- Search for hidden liabilities including tax obligations, liens, and undisclosed claims.
- Look behind the financials for customer concentration, deferred expenses, and owner add-backs.
- Structure the transition with consulting agreements, non-solicitation provisions, and a stakeholder communication plan.
Frequently Asked Questions
Q: What is due diligence in a business acquisition?
A: Due diligence is the process of thoroughly reviewing a business’s legal, financial, and operational records before purchasing it. In California business acquisitions, it typically covers contracts, financials, employment records, intellectual property, litigation history, and tax compliance.
Q: What is a change-of-control clause in a contract?
A: A change-of-control clause allows a counterparty to terminate or renegotiate a contract when the ownership of the business changes. These clauses are common in vendor agreements, software licenses, and commercial leases, and can significantly affect the value of a business being sold.
Q: What is an asset purchase vs. a stock purchase?
A: In an asset purchase, the buyer acquires specific assets and liabilities of the business. In a stock purchase, the buyer acquires the seller’s ownership interest in the entity, taking on all existing liabilities. Most small business acquisitions in California are structured as asset purchases for buyer protection.
Q: Can a California business include non-compete agreements?
A: California’s Business and Professions Code Section 16600 broadly restricts non-compete agreements. While there are limited exceptions, buyers should work with an attorney to understand what protections are enforceable and how to structure seller restrictions appropriately.
Q: How long does due diligence take in a California business acquisition?
A: Due diligence timelines vary by deal size and complexity, but typically range from 30 to 90 days. Rushing this process is one of the most common and costly mistakes buyers make.
Ready to Buy a Business in California?
An acquisition is not a transaction you want to navigate alone — or with a template checklist downloaded from the internet. The issues that surface after closing are almost always the ones that didn’t get the right attention before it.
At BMBR, our M&A attorneys work with California business buyers to conduct thorough due diligence, structure deals to manage risk, and negotiate protections that hold. If you’re considering acquiring a business, we’d welcome the chance to talk through where you are in the process.
Contact BMBR to schedule a consultation
This post is for informational purposes only and does not constitute legal advice. For advice on your specific situation, consult a qualified attorney.
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