Legal due diligence is one of the most critical stages in the small business M&A process. It’s how both sides confirm that the business’s financials, operations, and legal standing match what’s been presented and uncover any issues that could affect the deal.

Done well, it builds trust and clears the path to closing. Done poorly, it delays or kills the deal.

In a previous article, I walked through the full small business M&A process. In this post, I’m focusing on the legal due diligence process, what it involves, why it matters, and what buyers and sellers should know.

‍

The Process Starts With the LOI

The legal diligence process usually begins immediately after the letter of intent (LOI) is signed. The LOI sets the deal’s timeline, often includes an exclusivity period, and defines the transaction structure: stock sale, asset sale, merger, or hybrid.

Why does this matter? Because deal structure determines where to focus diligence efforts, including which documents will be reviewed, what third-party consents might be needed, and what risks could follow the buyer post-closing.

Even a small mismatch at this stage — like a contract that can’t be assigned in an asset sale or an operating license that must be obtained by the asset buyer — can introduce risk, delay, and unnecessary complexity. That’s why it’s important to work with legal and financial advisors early in the process to align the deal’s structure with your tax strategy and long-term business goals.

‍

What Legal Diligence Is Actually Looking For

Whether you’re buying or selling a small business, the core questions are the same:

• What exactly is being bought or sold?
• What risks are being inherited or disclosed?
• Are we contractually and legally prepared to close?

Buyers are focused on uncovering liabilities, third-party consents or requirements, integration issues, or surprises that could affect valuation or operations post-close.

Sellers are focused on maintaining operations and confidentiality, making required disclosures, and ensuring they can make accurate representations in the business purchase agreement.

In both cases, the goal is informed decision-making, not perfection. Due diligence helps you understand the risks and protect yourself before signing the final agreement.

‍

The Three Core Areas of Legal Due Diligence

1. Corporate Governance and Authority

Buyers need to confirm that the seller is a valid, properly formed legal entity and that the company has the right internal approvals to complete the sale. That includes reviewing:

• Creation documents and any amendments
• Shareholder or operating agreements
• Equity options or rights
• Board and equityholder resolutions
• Historical name changes, mergers, or conversions
• State qualifications and good standing
• Transaction authority, who is required to authorize the contemplated deal

This is where you are likely to surface and resolve issues with missing or inconsistent governance documents. Cleanup here prevents last‑minute surprises in the M&A closing process.

‍

2. Contracts (Where Most Issues Hide)

Contract review is often the most intensive part of legal diligence. Key concerns include:

• Assignment and change-of-control restrictions: Some contracts can’t be transferred without the other party’s consent, or provided for a termination right if a change of control occurs.
• Term, renewal, and termination rights: Having clarity on the length remaining on the current terms, what economic and legal requirements exist for renewals, and what the rights of the parties are to walk away “for convenience” can all raise questions about revenue or expense stability.
• Penalties or notice obligations: For example, when the closing timeline is 45 days but there is a vendor contract that requires 90 days’ notice for assignment, this contract may need to be renegotiated or excluded.

The goal here isn’t just identifying legal obstacles; it’s understanding their practical implications for integration, operations, and valuation.

Sometimes, it is not easy to identify the service or product being provided under a contract solely by the contract title. Additionally, whether a contract must be disclosed under the purchase agreement often depends on whether the contract amount or vendor/customer meets the required disclosure threshold in the agreement. 

To help streamline the contract review process, sellers should include the following in the summary of each key agreement:

1. Brief description of the contract’s purpose (e.g., software subscription, vendor services, lease agreement)
2. Total fees or payment amounts associated with the contract
3. Any special payment arrangements, such as:
   
   1. Profit-sharing agreements
   2. Unusual billing terms or payment schedules
4. Assignment or change-of-control restrictions (e.g. note whether third-party consent is required to transfer the contract)
5. Renewal and termination provisions 

Creating clear, concise summaries up front can reduce back-and-forth with buyer’s counsel and increase confidence in the sale process.

‍

3. Liens, Litigation, and Compliance

Buyers should expect a lien search, and sellers should be prepared to explain or clear any encumbrances on assets.

This includes:

• UCC filings from lenders or equipment lessors
• Security interests granted to vendors or landlords
• Financing statements tied to outdated or undisclosed agreements

Litigation review focuses on pending or recent lawsuits, regulatory actions, and settlement agreements. Even a closed matter can raise questions if it points to broader operational issues (e.g., serial HR disputes or past tax enforcement).

Compliance review focuses on third party consents, licenses, or permits required to conduct business.

‍

For Sellers: Get Your House in Order

If you’re preparing to sell your business, legal diligence starts long before the buyer’s counsel sends a request list.

Here’s what you can do now to set yourself up for success:

• Confirm that your governance documents are complete, signed, and up-to-date
• Organize and label key contracts especially customer, vendor, and lease agreements
• Review your cap table and equity records to ensure consistency
• Identify key contracts and flag any with transfer restrictions or odd terms
• Understand and if appropriate, resolve any known liens, expired qualifications, or missing filings

Even small cleanups can improve deal confidence and reduce friction during negotiation.  Assembling this information and creating a data room or shared file system can exponentially increase the ease of the diligence process.

More than that, by strategically and proactively preparing for the diligence process and addressing known issues, sellers can preserve leverage and avoid additional negotiation. The more surprises that show up late in diligence, the more likely a buyer is to renegotiate the price or demand extra protections. 

‍

For Buyers: Build Your Diligence Game Plan

When handled well, due diligence does more than protect your interests; it strengthens your negotiating position, informs smarter post-close decisions, and creates strategic advantage. The earlier you define your priorities, process, and review framework, the smoother the diligence phase will go…and the more value you’ll gain from it.

Here’s what you can do now to set yourself up for success:

• Create a simple diligence tracker early in the process so documents aren’t reviewed twice
• Flag and raise critical issues for discussion with buyer immediately 
• Stay focused on pragmatic issues that are material to the deal rather than fixating on minor imperfections in historical documents and records
• Always ask what a given risk means for the business, not just what it means legally

‍

Final Thought: Diligence is a Business Tool, Not a Legal Formality

In small business M&A, legal diligence isn’t about finding every issue. It’s about finding the issues that matter and putting them in context. As I mentioned previously, small business M&A operates by its own set of rules, where every deal is shaped by personalities, business realities, and the judgment of the people at the table.

The best legal counsel won’t just hand you a list of problems. They’ll help you understand what those problems mean for your deal, how to fix them, and when to walk away. That’s what turns legal due diligence from a checklist into a competitive advantage.

If you’re thinking about buying or selling a business, I’m happy to talk through how these principles apply to your deal. Request a consultation, and let’s find a time to connect.

‍

Here are some FAQs

What is the typical timeline for legal due diligence?

Usually about 30 to 90 days from LOI to closing, depending on asset versus stock sale and complexity.

How does diligence affect the purchase agreement?

Buyers rely on diligence to determine what assurances they need from the seller. Diligence findings inform deal terms, reps, warranties, and indemnities in the final business purchase agreement. The more unknowns or red flags that surface, the more likely the buyer is to negotiate stronger indemnity language, longer survival periods, or even escrow holdbacks.

When should financing details be addressed?

Early. Lenders typically require clean legal status, lien clearance, and contract assignments before funding.

Do I need external counsel for due diligence?

Yes. Legal due diligence is complex and critical. An experienced attorney will help you mitigate risk, navigate the M&A process with confidence, and ensure key findings are reflected in the final agreement.

Most buyers and sellers also work with financial and tax advisors to review accounting records, tax filings, and business performance. This team approach helps you make informed decisions and avoid costly surprises.

What documents are most critical for sellers to prepare?

Your business attorney will help you with this. Some big ones include governance records, cap tables and equity records, key contracts (customer and vendor), financial and tax records, litigation history, lien and debt information, business permits and licenses, employee and HR records, and compliance filings.

Can legal diligence kill a deal?

Yes, especially if there are serious hidden or unknown liabilities, unassignable contracts, or unresolved liens that weren’t disclosed upfront. No one wants to inherit unexpected financial or legal exposure. If issues aren’t disclosed upfront, buyers may demand a lower purchase price, hold back funds, or walk away entirely. Worse, undisclosed risks can signal a lack of transparency or poor recordkeeping, which erode trust.

‍