The Law Offices of Paul H. Appel – Your Trusted Business Law Partner in New Jersey
Due Diligence · Red Flags
Almost every review finds something. The skill lies in sorting the findings: which ones are routine clean-up, which ones change the price, and which ones mean the business is not what it was presented to be.
Perspective
Closely held businesses are run by busy owners, not compliance departments. Some gaps are normal. A red flag is a finding that affects value, the ability to close, or the seller's credibility.
The useful question about any finding is not “is this bad?” but “where does this belong?” Most problems can be pushed into one of a small number of responses: fixed before closing, covered in the agreement, reflected in the price, or accepted. A few cannot, and those are the ones that justify walking away.
The examples below are drawn from the kinds of issues that recur in small and mid-sized New Jersey acquisitions. They are illustrations, not a complete list.
Money
Cash
If income the seller describes is not on the tax returns, the buyer is being asked to pay for revenue that was never reported. Value the business on reported income, and recognize that the seller may have tax exposure that should stay firmly with them.
Sales tax
Unpaid sales and use tax is a state liability that can follow a business. In an asset deal the bulk sale notice helps flush it out; in either structure, a specific indemnity and escrow are appropriate.
Mixing
Family members on payroll, personal expenses through the company, related-party rent. Not unusual, but each must be identified so the true cost of running the business is clear and side arrangements end at closing.
Contracts and assets
If major customers have no written agreements, nothing obliges them to stay. Consider an earnout or holdback tied to retention, and a seller transition commitment.
A short remaining term, no renewal option or a landlord relocation right can undermine a location-based business. Make a new lease or extension a closing condition. See lease assignment in a business sale.
Trademarks, domains, software accounts or social media registered to the owner rather than the company must be assigned expressly. Add them to the transfer documents.
UCC filings by old lenders or equipment financiers must be paid off and terminated at closing. Make releases a closing deliverable.
Contracts that allow the other party to terminate on a sale need consent before closing, or the price should reflect the risk.
Licenses held by the owner personally, or expired, may not transfer. Confirm the buyer can obtain its own before committing.
People and claims
Misclassified workers are among the most common findings. New Jersey applies the ABC test to decide whether a worker is an employee for wage, unemployment and related purposes, and penalties for misclassification were strengthened in recent years. If much of the workforce is paid as contractors, the buyer should treat the exposure as a seller liability and plan to classify workers correctly going forward. The firm's page on employment due diligence goes further.
Other people-related findings include unpaid overtime, promises of bonuses or equity to staff that were never written down, and a key employee who is effectively running the business and has no reason to stay.
Choosing a response
| Response | Best for | Example |
|---|---|---|
| Cure before closing | Problems the seller can fix quickly | Paying off and releasing an old lien |
| Closing condition | Things that must happen for the deal to work | Landlord signs a new lease |
| Special indemnity and escrow | Known exposure of uncertain size | Pending wage claim or sales tax gap |
| Price adjustment | Real, quantifiable cost | Equipment needing replacement |
| Structural change | History too risky to inherit | Moving from a stock purchase to an asset purchase |
| Walk away | Problems that change what the business is | Revenue that exists only in cash and conversation |
Problems that diligence does not reveal are a separate risk, addressed through representations and indemnities — see undisclosed liabilities in a business purchase.
Questions & answers
In small and mid-sized New Jersey deals the recurring ones are income not reflected on tax returns, sales tax gaps, misclassified workers, key customers without contracts, a lease with little time left, IP or permits in the owner's personal name, and undisclosed disputes. None is unusual on its own; what matters is the size of the issue and the seller's openness about it.
Usually not. Most findings can be fixed before closing, covered by indemnity and escrow, or reflected in the price. Walking away makes sense when the problem changes what the business fundamentally is, when its cost cannot be estimated, or when the seller has not been candid. The firm's M&A practice helps buyers make that call.
Often, yes. Paying off liens, obtaining landlord consent, assigning IP into the company, renewing permits and settling minor disputes are all common pre-closing tasks. The purchase agreement should make completion of those tasks a condition of the buyer's obligation to close, so the fix actually happens.
Be very cautious. A buyer generally should not pay for income that cannot be verified from tax returns and bank records, and unreported income can carry tax exposure for the seller. Value the business on documented figures, keep the seller responsible for its past tax position, and discuss the issue with your accountant.
Your attorney
Every matter at the firm is handled personally by Paul — the same attorney reads the documents, gives the advice and negotiates on your behalf.
Contact
Describe what the business is dealing with — a contract on your desk, a deal in progress, a dispute or a company you are about to form. You will hear back from the attorney who handles the work.
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