After agreeing on a price, the buyer’s lawyer may send an extensive document request. As a buyer, you may notice discrepancies in the financials. This is due diligence, the stage where an Ontario acquisition is either confirmed or abandoned. The following explains how due diligence works and common points where deals fail.
What is due diligence in an acquisition?
Due diligence is the investigative phase of an acquisition, during which the buyer reviews the target’s legal, financial, tax, and operational records to verify the business’s representations. This process confirms value, identifies hidden risks, and influences the final price and terms. For sellers, it is when recordkeeping is scrutinized.
Due diligence bridges the gap between a seller’s claims and supporting evidence. The process requires documentation such as minute books, customer contracts, tax filings, employment agreements, and litigation history. When evidence aligns with the seller’s statements, confidence increases and the deal progresses. Discrepancies may lead to renegotiation, holdbacks, indemnities, or the buyer withdrawing.
What legal areas do buyers investigate first?
Buyers typically begin by reviewing corporate records, material contracts, litigation, regulatory and tax compliance, and intellectual property. These areas present the greatest risks to price or deal completion. Issues such as an unsigned share transfer or a customer contract with a change-of-control clause can jeopardize the transaction.
Here’s what each area is really testing:
- Corporate structure: Buyers review minute books, resolutions, share ledgers, and registers to confirm the seller’s ownership. Missing resolutions and unrecorded share transfers are common and can prevent a clean transfer of shares. Well-maintained corporate governance ensures this section is straightforward, which is ideal.
- Material contracts: Key customer, supplier, lease, and employment agreements are reviewed. Particular attention is paid to change-of-control or assignment clauses that may allow major customers to terminate agreements upon a change in ownership.
- Litigation: Buyers assess pending, threatened, or foreseeable claims. A single unresolved lawsuit may justify a significant holdback.
- Regulatory and tax compliance: Buyers review filings, audits, licences, and outstanding assessments. This review is especially rigorous in regulated industries.
- Intellectual property: Buyers verify ownership of the brand, code, and trademarks, and confirm that ownership is registered and enforceable.
What actually kills a deal in due diligence?
Most deals do not fail due to a single major issue. Instead, multiple small problems can erode trust, such as unreconciled cap tables, financials that do not match tax filings, unsigned contracts, or slow and defensive disclosure by the seller. Buyers interpret disorganization as risk, which can lead to price reductions or withdrawal.
The specific killers I see most often:
Financials that don't tie to the tax filings
If internal statements differ from T2 filings, all financial figures become questionable. The buyer may lose confidence in the information provided, and even minor discrepancies can prompt significant renegotiation. Ensure your accountant and lawyer reconcile these records before presenting them to the buyer.
An unclear cap table
If ownership records are inconsistent, such as untracked options, untransferred shares, or verbal equity promises, the buyer cannot be confident in obtaining clear title. A disorganized cap table can delay or reduce the value of the deal. Maintaining a current shareholder agreement and accurate corporate records is essential.
The seller who treats disclosure as an attack
Diligence requests can feel intrusive. However, if a seller is slow, evasive, or defensive, the buyer may assume there are underlying issues. Thorough preparation and organized disclosure help build buyer confidence.
Why should sellers run their own due diligence first?
Sellers who conduct a pre-sale review, or vendor audit, can identify and resolve issues before buyers use them as leverage. Maintaining organized minute books, reconciled financials, signed contracts, and a clean cap table streamlines the process, reduces renegotiation, and helps preserve value. Ideally, this preparation should begin twelve to twenty-four months before selling.
Every issue discovered by a buyer becomes leverage in negotiations. Addressing issues in advance allows the seller to retain that leverage. For example, an unsigned key contract identified by the buyer may reduce the price, while a contract signed in advance avoids this problem.
Deal structure is also important. To claim the lifetime capital gains exemption on a share sale, your corporation must meet specific requirements, some of which require advance planning. Identifying the need for purification or restructuring just before closing is much more costly than addressing it early. Sellers should consider exit planning well before starting the sale process.
How does deal structure change what gets reviewed?
The structure of the transaction, whether a share deal or an asset deal, determines the scope of due diligence. In a share purchase, the buyer acquires the entire company, including its history, liabilities, and tax exposure, requiring comprehensive review. In an asset purchase, the buyer selects specific assets and typically excludes liabilities, resulting in a narrower review.
This distinction influences key decisions. Buyers often prefer asset deals to avoid unknown liabilities, while sellers may favor share deals for capital gains benefits. These preferences are negotiated and determine which documents are most relevant. Understanding these trade-offs is important before agreeing to a transaction structure.
How is confidential information protected during the process?
A well-drafted non-disclosure agreement (NDA) governs the exchange of sensitive information before and during due diligence. It protects financial data, customer lists, and trade secrets regardless of whether the deal closes. Serious buyers expect to sign an NDA, and sellers should not share detailed information without one.
Beyond the NDA, sellers manage disclosure by providing information in stages. Initial rounds include summary-level data, while detailed contracts, customer names, and pricing are shared once the buyer demonstrates genuine intent. A structured data room allows tracking of document access, which is valuable if the deal does not proceed and a competitor was involved.
Frequently asked questions
How long does due diligence take in an Ontario acquisition?
For most small and mid-sized private transactions, due diligence typically lasts four to eight weeks, depending on the business size, record quality, and contract or regulatory complexity. Well-prepared sellers often complete this phase more quickly.
Who pays for due diligence?
Each party typically pays its own advisors. The buyer covers legal, financial, and tax reviews, while the seller pays for its own preparation and responses. Costs increase with complexity, so businesses with organized records and simple structures incur lower review expenses.
Can problems found in due diligence be fixed instead of ending the deal?
Often, yes. Many issues can be resolved through price adjustments, holdbacks, escrows, specific indemnities, or conditions that the seller must meet before closing. Deals typically fail only when a problem is fundamental or trust is lost, not merely because an issue is identified.
What's the difference between legal and financial due diligence?
Legal due diligence reviews contracts, corporate records, litigation, intellectual property, and compliance. Financial due diligence focuses on revenue quality, margins, working capital, and reconciliation of statements to tax filings. These processes overlap and are most effective when coordinated between your lawyer and accountant.
Do I need a lawyer if I have an accountant on the deal?
Accountants and lawyers have distinct roles. Accountants review financial data, while lawyers assess legal foundations such as ownership, contracts, liabilities, and transaction documents. For any significant acquisition, coordinated legal and financial reviews are essential to identify issues that might otherwise be overlooked.
Due diligence is where value is confirmed or lost. If you’re preparing to buy or sell a business in Ontario, book a confidential consultation to work through your diligence process with a clear plan.
