Due Diligence
The buyer's investigation of a target business before committing to a transaction, examining financials, operations, contracts, IP, regulatory compliance, litigation, employment, tax, and other material risk and valuation elements.
Due diligence is the buyer's investigation of the target business before committing to a transaction, examining the target's financials, operations, contracts, intellectual property, regulatory compliance, litigation, employment matters, tax position, and other elements material to the buyer's valuation and risk assessment.
Categories of diligence
Legal: corporate organization and good standing, contracts, IP, litigation, regulatory licenses, employment matters, real estate, environmental, data privacy. Financial: historical financial statements, quality of earnings analysis, working-capital normalization, debt-like items, indebtedness, capitalization. Tax: federal, state, sales/use, employment, property tax positions and exposures. Operational: customer concentration, supplier relationships, key employee retention, technology systems. Insurance: coverage adequacy, claims history, run-off requirements.
Diligence and indemnification
Due-diligence findings typically populate the seller's disclosure schedule. Issues identified in diligence may be: (1) addressed by purchase-price reduction; (2) addressed by specific indemnification (a "special indemnity"); (3) addressed by retained liability assignment; (4) addressed by escrow or holdback; or (5) sufficient to terminate the deal.
Sandbagging implications
A buyer who discovers a breach of representation during diligence and closes anyway may have its post-closing indemnification claim limited under an anti-sandbagging clause, and Texas law on the default rule (where the agreement is silent) is unsettled. See Sandbagging.
Diligence quality directly affects representations and warranties insurance underwriting, indemnification scope, and post-closing dispute likelihood. The 2025 RWI market has heightened underwriter scrutiny of diligence quality. Inadequate diligence is a leading cause of post-closing disputes and indemnification claims.
Companion article: Selling Your Business in Texas