When you’re looking to buy a business, there’s one phase that can truly make or break the deal: due diligence. It’s not just about crunching numbers or touring facilities. It’s about digging deep into the documents that quietly reveal the health, risks, and integrity of the business you’re about to acquire.

In this guide, we’ll walk you through a warm, clear-eyed deep dive into how to spot red flags in a target company’s legal documents. Whether you’re a seasoned buyer or exploring your first acquisition, this breakdown will help you approach legal due diligence with confidence.

Understanding Due Diligence: An Overview

So, what exactly is due diligence? Think of it as your investigative toolkit. It’s the process buyers use to verify every aspect of a target company—from finances and operations to legal and compliance issues.

Due diligence helps ensure you’re not buying into hidden problems. It’s how you make sure you’re paying the right price, assuming the right risks, and stepping into a business with your eyes wide open.

There are many kinds of due diligence—financial, operational, commercial, and of course, legal. And legal due diligence? That’s where the real red flags like to hide.

Importance of Legal Document Review in Due Diligence

Reviewing legal documents is like reading the fine print of the company’s life story.

Are there contracts that could expire or be terminated once you take over? Are there pending lawsuits? Are they in compliance with local and federal regulations?

Without a thorough legal review, you might walk into a deal that looks shiny on the outside but is riddled with liabilities. Spotting these risks upfront can save you from massive legal headaches (and bills) later.

Common Types of Legal Documents to Analyze

Let’s get into the meat of it. These are the key legal docs you’ll want to have on your checklist:

• Articles of Incorporation and Bylaws

• Shareholder Agreements

• Board Meeting Minutes

• Employment Contracts

• Vendor and Customer Agreements

• Lease Agreements

• Loan Documents and Promissory Notes

• Intellectual Property Assignments

• Litigation History and Legal Correspondence

Each of these holds clues about how the business operates, what risks it carries, and whether it’s worth the investment.

Key Red Flags to Look for in Legal Documents

Now let’s talk red flags. Here are some warning signs that should raise your eyebrows—and possibly trigger further investigation or negotiation:

• Unclear or missing ownership records

• Undisclosed liabilities or debts

• Pending or past lawsuits

• Contracts with unusually restrictive or one-sided terms

• Expired licenses or missing permits

• Undocumented employee arrangements

• Outstanding tax obligations

None of these automatically kills a deal. But they should definitely inform you how to proceed or whether you should proceed at all.

Analyzing Contracts: What to Watch Out For

Contracts are the lifeblood of any business. But poorly written or risky agreements can be a trap.

Look out for:

• Termination clauses that give other parties the right to cancel if ownership changes

• Exclusivity agreements that limit the company’s ability to grow

• Indemnity clauses that put you on the hook for past actions

• Automatic renewal terms that may lock you into unwanted deals

Pay close attention to high-value customer and vendor contracts. If those relationships are shaky, the company’s future cash flow could be, too.

Corporate Governance Documents: Red Flags and Risks

Governance documents outline how the company is run. They also tell you who has the power to make decisions, sign contracts, and sell shares.

Be cautious of:

• Disputes among shareholders

• Non-compliance with corporate formalities

• Bylaws that require unanimous board approval for decisions

• Restrictions on transferring shares

These risks can stall or derail your deal if not handled proactively.

Intellectual Property Considerations in Due Diligence

If the company’s value is tied to its brand, software, or content, pay attention.

Red flags here include:

• Unregistered trademarks or copyrights

• IP is  assigned to individual founders instead of the company

• Licensing agreements with weak or expired terms

• Previous employment agreements that don’t include IP assignment clauses

Your attorney should verify that all intellectual property is owned by the company and properly documented.

Financial Statements: Spotting Inconsistencies and Irregularities

Yes, this is more of a financial check, but it has legal consequences.

Inconsistencies between reported revenue and contractual obligations can indicate:

• Underreported income

• Revenue recognition problems

• Deferred liabilities that weren’t disclosed

If it smells fishy, dig deeper. And bring in an accountant who’s used to merger and acquisition reviews.

Engaging Legal Experts: When and Why It’s Necessary

Here’s the truth: most red flags won’t jump out at you unless you know exactly where and how to look. That’s why partnering with a skilled business attorney can be the difference between success and regret.

They’ll:

• Review the documents with a trained legal eye

• Spot inconsistencies and overlooked obligations

• Help you negotiate better terms (or walk away if needed)

At Carbon Law Group, we’ve helped buyers across Los Angeles navigate complex business acquisitions with clarity and confidence. Our team knows how to spot the traps others miss.

Conclusion: Best Practices for Effective Due Diligence

The best deals are built on strong foundations. Due diligence is your chance to look beneath the surface—to go beyond the pitch deck and into the fine print.

By carefully reviewing legal documents, watching for red flags, and working with the right advisors, you can protect your investment and set yourself up for long-term success.

Thinking about buying a business in Los Angeles? Let’s talk. The earlier we’re involved, the more value we can bring to the table.