Due Diligence Checklist for Buying a California Business

Buyers find most problems in diligence or not at all. Once you close, your protection is whatever the purchase agreement says, and collecting on a seller’s broken promise is a lawsuit. This checklist is written for someone buying a small or mid-sized California business, with the state-specific items marked.

How does due diligence work when buying a business?

It runs in a window set by the letter of intent. The seller opens a data room or sends documents, your CPA and your attorney review them, you ask follow-up questions, and you either sign the purchase agreement, renegotiate, or walk away.

Split the work by who is trained to find each problem:

• Your CPA: the financial statements, tax returns, quality of earnings, working capital, and the tax effect of the structure.
• Your attorney: the entity records, contracts, lease, liens, litigation, employment, licenses, and the purchase agreement that allocates what’s found.
• You: customers, suppliers, staff, equipment condition, and whether you can run it.

Each finding becomes a price change, a special indemnity, a condition to closing, or a reason to walk.

Financial and tax checklist

• Three to five years of federal and California tax returns for the business
• Profit and loss statements and balance sheets for the same years, plus year to date
• Bank statements that tie to the reported revenue
• The seller’s SDE or EBITDA schedule with support for every add-back (see how to value a small business)
• Accounts receivable and payable aging
• Customer concentration: the top ten customers and their share of revenue
• Debt schedule, including equipment loans, lines of credit, and anything personally guaranteed
• Sales and use tax returns and any CDTFA audit history (California)
• Payroll tax filings with EDD and any notices (California)
• FTB returns and any notices, including proof the annual LLC or corporation tax is paid (California)

Entity and good standing checklist

If you’re buying shares or membership interests, you’re buying the entity’s whole past. If you’re buying assets, you still need to know the seller has authority to sell.

• Articles of incorporation or organization, bylaws or operating agreement, and all amendments
• Minutes, written consents, and the owner ledger showing who owns what
• Any buy-sell agreement, option, or right of first refusal that could block the sale (see buy-sell agreements)
• Secretary of State status and the most recent Statement of Information (California)
• FTB status (California)
• A written approval of the sale by the seller’s board, members, or managers, as its documents require

Status matters because the FTB can suspend the powers, rights, and privileges of an LLC or corporation that doesn’t pay its tax (Rev. & Tax. Code § 23301). Don’t close with a suspended seller. Make revival a condition to closing. See suspended LLC or corporation in California and the California Statement of Information.

California tax successor liability checklist

This is the part out-of-state checklists leave out, and the one that can make you pay the seller’s tax bill. Each item has its own clearance process, and escrow should hold the money until each comes back.

Agency	The risk	What to get
CDTFA (sales and use tax)	A buyer who doesn’t withhold for the seller’s unpaid tax is personally liable up to the purchase price (Rev. & Tax. Code § 6812)	A tax and fee clearance, which the CDTFA calls a Certificate of Payment
EDD (payroll taxes)	A buyer who doesn’t withhold for unpaid contributions is personally liable up to the purchase price (Unemp. Ins. Code § 1733)	Certificate of Release of Buyer, form DE 2220
Bulk sale creditors	If the bulk sale law applies and the buyer skips the notice, creditors can reach the buyer, generally capped at twice the net contract price (Com. Code § 6107)	Recorded and published notice at least 12 business days before the sale, handled through escrow (Com. Code § 6105)
County assessor and BOE	Buying control of an entity that owns real property triggers reassessment, and a late filing carries a penalty	A change in ownership statement to the BOE within 90 days (Rev. & Tax. Code § 480.1)

The CDTFA’s deadline runs from the latest of the buyer’s written request, the date of sale, or the date the seller’s records are made available for audit (Rev. & Tax. Code § 6812). Ask for clearance early. Under the same section, if the agency doesn’t issue the certificate or a notice of the amount due within 60 days after that date, the buyer is released from the duty to withhold.

EDD has 30 days from a request to issue its certificate or a statement of what’s owed, and silence counts as a certificate that nothing is due (Unemp. Ins. Code § 1732). The bulk sale law reaches only sellers whose principal business is selling inventory from stock, including manufacturers, and restaurants (Com. Code § 6103). The pillar guide, how to sell a small business in California, explains each rule in detail.

The property tax rule applies to entity purchases. Obtaining more than 50 percent of a corporation’s voting stock, or a majority interest in an LLC or partnership, is a change in ownership of the real property the entity owns (Rev. & Tax. Code § 64(c)). Budget for the new property tax bill before you agree on price.

Contracts and lease checklist

• Every customer and supplier contract worth keeping, with the assignment and change-of-control clauses flagged
• Equipment leases and financing agreements
• Franchise agreement, if any, and the franchisor’s transfer requirements
• Non-competes, NDAs, and exclusivity the seller has signed with others
• The real property lease, all amendments, and any guarantee

The lease deserves its own read. If it requires the landlord’s consent to assign but gives no standard, California implies that consent can’t be unreasonably withheld (Civ. Code § 1995.260). Many commercial leases do set a standard, charge a transfer fee, or let the landlord raise the rent on assignment. Check the remaining term against your loan and your plans. See commercial lease review for California tenants and personal guarantees on commercial leases.

Liens, litigation, and insurance checklist

• UCC financing statement search at the California Secretary of State, for the seller entity and each owner (California)
• Tax lien and judgment searches in the counties where the business operates
• Pending or threatened lawsuits, demand letters, and government agency claims
• Insurance policies and loss history, including workers’ compensation
• Product warranties and customer complaints

A UCC filing means a lender has a security interest in the business’s assets. In an asset sale, those liens should be paid from escrow and released at closing. If you find an active lawsuit, have litigation counsel assess it before you sign. I review the documents but don’t evaluate litigation risk.

Employees checklist

• Employee roster with pay rates, hire dates, accrued vacation, and who holds key licenses or client relationships
• Independent contractors and how they were classified (see employee or independent contractor in California) (California)
• Wage and hour claims, Labor Commissioner filings, and PAGA notices (California)
• Benefit plans, retirement plan status, and any unfunded obligations
• Offer letters, bonus promises, and any retention or change-of-control payments

Misclassified workers and unpaid overtime follow the entity in a stock purchase. In an asset purchase, you can leave most of that behind, but not all of it. Buyers commonly ask for a special indemnity and a holdback. If you plan to keep the seller’s managers, remember that California voids non-competes for employees. The seller can sign one. The staff can’t. See non-competes in California.

Licenses, permits, and intellectual property checklist

• Every license and permit the business needs, and whether it transfers or you must apply for your own. California’s Small Business Advocate says a buyer may need its own seller’s permit, because permits aren’t transferable. (California)
• Contractor, professional, health, alcohol, or other state licenses tied to a specific person or entity (California)
• Trademarks, domain names, social media accounts, and the business name’s fictitious business name filing (see DBAs in California)
• Software licenses and who owns any custom code or website content
• Customer data and the privacy policies it was collected under

A worked example: buying a Thousand Oaks landscaping company

A buyer is purchasing a landscaping company in Thousand Oaks for $700,000 as an asset sale. Diligence finds these issues:

• The seller’s sales tax filings are current, but the CDTFA clearance request goes in late. The buyer moves the closing date instead of waiving the holdback.
• Six crew members were paid as independent contractors. The buyer requires the seller to hold $60,000 in escrow for 18 months against wage claims and adds a special indemnity.
• A UCC search shows the seller’s equipment lender has a blanket lien. The lender’s payoff is paid from escrow, and a release is a closing condition.
• The yard lease has 14 months left and requires the landlord’s consent “in its sole discretion.” The buyer makes a new five-year lease a condition to closing.
• The contractor’s license is tied to the seller’s qualifying individual, who is retiring. The buyer arranges its own license and qualifier before closing.

Two of those findings changed the price terms, and three became closing conditions.

Frequently asked questions

How long does due diligence take when buying a small business?

The letter of intent sets the window. State clearances can take longer than the review itself. The CDTFA says a clearance can take 60 days or more when an audit is needed, so ask for it at the start.

What is the most important part of due diligence?

Verifying the cash flow. If the tax returns and bank statements don’t support the seller’s earnings, the price is wrong. In California, the tax clearances are a close second, because skipping them can make you liable for the seller’s debts.

Can I rely on the seller’s representations instead of diligence?

Representations and warranties give you a claim if they’re false. A claim isn’t money. Collecting means a lawsuit against a seller who may have spent the proceeds, so diligence and a holdback beat a promise.

Do I need diligence if I’m buying from a family member or partner?

Yes, though it can be lighter. Tax clearances and lien searches protect you whoever the seller is, and a clean record now avoids a family fight later.

Is diligence different in a stock purchase than in an asset purchase?

Yes. In a stock or membership interest purchase, you take all the entity’s liabilities, known and unknown, so the review has to go deeper into taxes, employment, and litigation. In an asset purchase, you still face California’s successor rules for sales and payroll taxes.

What if I find fraud after closing?

That’s a claim against the seller, and it belongs with litigation counsel. I can refer you. Keep every document the seller gave you in diligence, because it’s your evidence.