21 May 2026
By Louis Francis, Solicitor, Corporate, Gilson Gray
Under an asset purchase agreement, the buyer can selectively “cherry-pick” the assets and liabilities they wish to acquire. Whereas, on the acquisition of the entire issued share capital of a target company, the buyer will be exposed to the full spectrum of the target company’s historical, current, and potential liabilities. Robust due diligence is therefore essential not only to identify risks, but also to structure effective contractual and commercial protections. This article discusses what some of those “red flags” may be and how a buyer can mitigate those risks.
1. Financial Irregularities
One of the first warning signs arises from inconsistencies or gaps in financial records. Points for clarification with the seller include unexplained revenue fluctuations, incomplete management accounts, unusual cash‑flow patterns, aggressive revenue recognition, or a lack of audit trails. These issues may signal poor internal controls, overstated profitability, or undisclosed liabilities.
To mitigate these potential risks, buyers should seek to gain access to financial records, up-to-date management accounts and obtain accounting advice. Any matters of concern identified can be addressed in the purchase agreement documentation, including price adjustment mechanisms, specific indemnities, retention of consideration, or fixing value via lockbox provisions to safeguard against future losses.
2. Problematic Contracts and Change‑of‑Control Risks
Customer and supplier contracts can reveal significant vulnerabilities. A high dependence on a small number of clients, contracts near expiry, or those containing change‑of‑control provisions capable of triggering termination upon completion, all pose material risks. Missing or partially signed agreements can also provide uncertainty and become equally problematic.
Mitigation can include diligence on customer and supplier contracts, along with warranties covering the accuracy and enforceability of key contracts where a change of control has occurred. Where critical relationships and key contracts in the company are jeopardised by the potential purchase, buyers can insist on obtaining third‑party consents before completion or having “split-completion” where the transaction only completes following satisfaction (or waiver) of certain “conditions precedent”. For example, where gaps exist, a buyer may require renegotiation, supplemental agreements and/or novation of key customer/supplier contracts prior to completing the deal.
3. Employment Considerations
Because employees remain in the target entity and don’t transfer to the buying entity, any employment‑related issues will become the ultimate responsibility of the buyer on completion. Typical red flags include misclassified contractors, undocumented bonus schemes, unresolved grievances, or ongoing tribunal claims.
The SPA should include comprehensive warranties relating to employees, accurate disclosures of remuneration arrangements, and indemnities covering any identified employment disputes. Where the buyer has concerns about workforce matters, they may also seek a long-stop date or extended timeframe before completion to allow for fuller investigation of employment-related issues.
4. Tax Exposure
Tax risk is a central focus in any share sale, and the tax position of the target company should be well understood before proceeding with any purchase. Particular “red flags” include overdue Companies House filings or HMRC tax filings, unclear VAT, PAYE or Corporate Tax practices, or open enquiries from HMRC.
Buyers should insist on a detailed tax due diligence report, extended tax warranties & indemnities, and a tax covenant ensuring the seller covers pre‑completion liabilities. For higher‑risk targets, a buyer might withhold part of the purchase price until any tax liabilities are ironed out.
5. Regulatory, Compliance, and Data Protection Issues
Non‑compliance with regulatory requirements (particularly in regulated sectors) can lead to penalties, reputational harm, or loss of licences. GDPR and data protection matters are increasingly prominent, and inadequate privacy policies, poor data handling practices, or security vulnerabilities are common warning signs.
As a buyer, you should request all evidence of regulatory compliance, updated policies, and licence validity. Specific indemnities relating to known breaches and warranties covering historic compliance should be considered as forming part of the share purchase agreement.
6. Litigation and Disputes
The buyer should seek to understand the full extent of any ongoing litigation or threatened claims that can materially affect the value and the liability of the target company. A buyer should also look for clarification and understanding on any previous litigation claims that have been settled or may be subject to appeal. Furthermore, if the target company appears to have a pattern of disputes, this may signal deeper cultural or operational issues within the target company.
Buyers should conduct thorough legal due diligence on the litigation status of the target company. Particularly from the seller’s perspective, setting out the details of known claims and disputes in a disclosure letter will be critical to ensure there is no breach of warranties. The buyer should then seek to be protected against exposure to known claims via specific indemnities, leaving warranties to cover any undisclosed disputes and protect against future surprises should the value of the shares decrease due to that litigation claim.
Conclusion
Due diligence in a share sale is as much about understanding risk as it is about identifying value. Red flags do not always derail a deal, but they do require careful assessment and strategic mitigation. Through a combination of detailed investigation, targeted warranties & indemnities and well‑structured completion mechanics, buyers can protect themselves effectively and proceed with confidence.
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