Due diligence often begins before the parties have agreed upon every term of the transaction. A prospective buyer may conduct preliminary investigation before signing a letter of intent and then undertake more extensive due diligence once the seller provides access to financial records, contracts, corporate documents, tax information, and other confidential materials.

The important point is that meaningful due diligence should occur while the buyer still has the ability to act upon what is discovered.

Due diligence loses much of its protective value when important questions are postponed until the parties are already committed to closing.

The timing and scope will depend upon the transaction, the terms of the letter of intent or other preliminary agreements, the information available, and the issues identified as the investigation progresses.

There is no standard period that is appropriate for every transaction.

The time required depends upon the size and complexity of the business, the quality and organization of its records, the number of contracts and employees involved, regulatory requirements, the nature of its assets and operations, and what the initial investigation reveals.

A relatively straightforward transaction involving a well-organized company may proceed efficiently. A transaction involving multiple entities, inconsistent financial records, substantial intellectual property, significant employment issues, regulatory approvals, international operations, litigation, tax concerns, or environmental exposure may require considerably more investigation.

The appropriate question is not simply how quickly due diligence can be completed. It is whether the material questions raised by the transaction have been adequately investigated before closing.

The documents requested depend upon the business and transaction, but due diligence commonly includes financial statements, tax returns, accounting records, corporate and ownership records, material contracts, leases, debt and financing documents, employee information, intellectual property records, licenses and permits, insurance information, litigation records, and documentation concerning significant assets and liabilities.

Technology, cybersecurity, privacy, environmental, regulatory, real estate, and other records may also be important depending upon the company.

The document request is only the beginning.

A document should help answer a question about the business. If the information provided creates another material question, due diligence should not stop merely because the requested document was produced.

Some of the most significant red flags are inconsistencies.

Financial statements that do not reconcile with tax returns or underlying records deserve explanation. So do material changes in revenue or margins, unusual related-party transactions, missing corporate records, unclear asset or intellectual property ownership, significant customer concentration, undocumented business relationships, unresolved tax matters, employment compliance problems, threatened litigation, and licenses or contracts that may not survive the transaction.

The behavior surrounding the diligence process can also matter. Repeated difficulty obtaining material information, incomplete responses, changing explanations, or an inability to provide records that should ordinarily exist may warrant additional investigation.

A red flag does not necessarily mean there is a serious problem. It means there is a question that should be satisfactorily answered before it is treated as an acceptable risk.

Discovery of a problem does not automatically end the transaction.

The first step is usually to understand its nature, magnitude, likelihood, and potential consequences. Additional investigation may establish that the issue is limited, can be corrected, or presents less risk than initially believed.

Other findings may require action before closing. The parties may negotiate remediation, obtain a required consent or clearance, adjust the purchase price, modify transaction terms, establish an escrow or holdback, negotiate specific representations or indemnification, or make resolution of the issue a condition of closing.

Some findings can materially change the economics or risk of the proposed transaction.

The purpose of discovering a serious issue during due diligence is to give the parties the opportunity to make an informed decision about it before the transaction is complete.

Yes. Information discovered during due diligence may affect the assumptions upon which the original valuation or proposed terms were based.

If earnings are lower or less sustainable than expected, working capital requirements are greater, an important customer relationship is at risk, an unexpected liability exists, or substantial investment will be required after closing, the buyer may reconsider the economics of the transaction.

Other findings may be addressed through changes to representations and warranties, indemnification provisions, escrow or holdback arrangements, closing conditions, purchase price adjustments, or transaction structure.

Due diligence connects what is discovered about the business to what the parties are actually willing to agree to.

A seller should consider conducting its own pre-sale review before a serious buyer begins formal due diligence.

This provides an opportunity to examine financial, tax, corporate, contractual, employment, intellectual property, regulatory, and other records; identify missing or inconsistent information; correct matters that can appropriately be corrected; and prepare for issues that will require explanation or disclosure.

It can also help the seller anticipate the questions a sophisticated buyer and its professional advisors are likely to ask.

The buyer should not have to be the first person to discover a material weakness in the seller's records, documentation, compliance, or business operations.

Preparation cannot eliminate every issue, but it can reduce avoidable surprises at a point when valuation, negotiating leverage, timing, and buyer confidence may already be at stake.

Yes. California businesses may present legal, tax, employment, privacy, environmental, regulatory, and other issues that require particular attention.

Depending upon the company, due diligence may need to examine California wage-and-hour practices, employee and independent contractor classification, potential PAGA exposure, state and local tax obligations, sales and use tax, payroll tax matters, privacy obligations under the CCPA and CPRA, environmental requirements, professional or industry licensing, and other California-specific compliance matters.

The relevance of any particular issue depends upon the business being investigated.

A diligence process developed for a transaction elsewhere should not simply assume that the same questions are sufficient for a business operating in California.

The appropriate team depends upon what is being acquired and the risks presented by the transaction.

Attorneys may examine ownership, contracts, corporate authority, employment matters, intellectual property, litigation, regulatory obligations, and other legal issues. Accountants and financial professionals may examine earnings, cash flow, financial records, working capital, liabilities, and the underlying evidence supporting reported performance. Tax professionals may evaluate historical compliance, potential exposure, and the consequences of the proposed transaction. Business advisors may examine operations, customer and vendor dependencies, key personnel, systems, processes, and the sustainability of the enterprise.

Other specialists may be required for environmental, technology, cybersecurity, benefits, real estate, valuation, regulatory, or industry-specific matters.

The important question is not how many professionals participate in due diligence. It is whether the people involved collectively have the experience necessary to identify the material issues, understand how those issues affect one another, and determine what they mean to the transaction.