A Buyer’s Guide for Small to Mid-Sized Business Acquisitions (M&A Due Diligence Canada)
M&A due diligence is the structured process by which a buyer investigates a target business before committing to an acquisition. In the Canadian SMB context, deals typically range from $1 million to $50 million. Due diligence covers financial statements and tax compliance, corporate records and contract review, operational dependencies, intellectual property, and regulatory standing. The findings shape whether the deal proceeds, at what price, and on what terms.
Why the Structure of Share Purchase vs. Asset Purchase Determines the Scope
Before a single document is requested, the structure of the transaction determines what you are actually acquiring and therefore what risks you need to investigate.
In a share purchase, the buyer acquires the shares of the target corporation. The corporation and all of its history, its contracts, its employees, its tax liabilities, its litigation, and its undisclosed obligations transfer with it. The buyer inherits everything the corporation has ever done, known or unknown. This structure requires the most comprehensive due diligence because the buyer is taking on a legal entity with a full past, not just its assets.
In an asset purchase, the buyer selects which assets and which liabilities to assume. The buyer does not acquire the target corporation itself and is generally not responsible for liabilities it does not expressly assume. Due diligence still covers the assets being acquired and the liabilities being assumed, but unknown or unassumed historical liabilities generally stay with the vendor’s corporation. Asset purchases are common where the parties want a clean break from pre-closing liabilities or where the target’s corporate structure carries risks the buyer is unwilling to inherit.
The choice of structure is negotiated between the parties and has significant tax consequences for both sides. Our overview of selling a business in Ontario addresses the tax treatment from the vendor’s perspective. From the buyer’s perspective, the structure choice directly determines the scope, depth, and priority of the due diligence workstream.
Before Due Diligence Begins. NDA and Letter of Intent
Due diligence involves the disclosure of confidential financial, legal, and operational information about the target business. Before any documents are shared, the parties execute a Non-Disclosure Agreement (NDA), sometimes called a Confidentiality Agreement, that governs how the buyer may use the information received, restricts disclosure to the buyer’s advisers, and typically prevents the buyer from soliciting the target’s employees or customers during the process.
Once the parties have agreed in principle on the key commercial terms, they typically execute a Letter of Intent (LOI) or term sheet. The LOI is generally non-binding on the substantive transaction (it is not the purchase agreement) but contains binding provisions on exclusivity and confidentiality. The exclusivity clause, typically 30 to 90 days prevents the vendor from soliciting or entertaining offers from other buyers while the buyer conducts due diligence. This protection is essential for the buyer, who will invest significant time and professional fees in the process.
The LOI also sets the framework for due diligence by establishing the proposed structure (share or asset), the indicative price and any pricing adjustments (typically a working capital adjustment mechanism), the anticipated closing conditions, and which party bears transaction costs if the deal fails to close. Ambiguities in the LOI become disputes in the purchase agreement. A lawyer should review and ideally draft the LOI before it is signed.
Financial Due Diligence
Financial due diligence verifies the economic substance of what the buyer is paying for. For a business valued on a multiple of EBITDA, every dollar of normalized earnings determines a multiple-times impact on purchase price. The financial review covers three to five years of historical results and identifies adjustments that will affect price.
Financial statements
Requests for a minimum of three years of financial statements are preferred, but reviewed or compiled statements are common for SMBs. Examine revenue recognition policies, the consistency of accounting treatment across periods, and whether any significant year-over-year changes are explained by the business or appear anomalous.
Quality of earnings (QofE) analysis
The most important financial due diligence exercise for a multiple-based acquisition is the quality of earnings analysis, a systematic review of whether the reported EBITDA is sustainable, recurring, and clean. Common adjustments include owner’s compensation above or below market replacement cost, personal expenses run through the business, non-recurring revenue items or one-time expenses, related-party transactions at non-arm’s-length prices, and rent paid to a related party at above- or below-market rates. Each adjustment flows directly into the purchase price negotiation.
Working capital
Most SMB purchase agreements include a working capital adjustment mechanism. if the working capital delivered at closing is above or below a negotiated target (“peg”), the purchase price adjusts dollar-for-dollar. Establishing the appropriate peg requires analyzing 12 to 24 months of working capital history to identify seasonality and understand the normal operating cycle, and determine what level of working capital is actually required to run the business. This is one of the most frequently disputed financial issues in SMB M&A.
Accounts receivable and inventory
Review the AR aging schedule. Receivables over 90 days are often uncollectable and should be excluded from the working capital peg or adjusted from price. For businesses carrying inventory, assess the valuation methodology, the proportion of slow-moving or obsolete stock, and whether physical counts have been conducted recently.
Capital expenditures and deferred maintenance
Assess the condition of equipment, fleet, IT systems, and facilities. Deferred capex maintenance and replacement spending that the seller has postponed is a real liability that may not appear on the balance sheet but will fall on the buyer post-closing.
Off-balance-sheet obligations. Identify personal guarantees given by the corporation, operating lease commitments, earn-out obligations from prior acquisitions, and contingent liabilities. These often do not appear on the balance sheet but represent real financial exposure.
Tax Due Diligence
Tax due diligence is among the most consequential workstreams in a share purchase because the buyer inherits all of the target corporation’s pre-closing tax liabilities, including those not yet assessed by the CRA. The normal reassessment period under Income Tax Act s. 152 is three years from the date of the original assessment (or four years for CCPCs in most circumstances), extendable to six years where there has been a misrepresentation attributable to neglect, carelessness, willful default, or fraud. A buyer who acquires shares of a corporation is acquiring all of that exposure.
Income tax compliance
Review all T2 corporate income tax returns for the open reassessment years. Confirm that returns have been filed on time and that the corporation has no outstanding assessments, notices of objection, or appeals. Review CRA correspondence for any audit activity, requests for information, or proposals to reassess.
HST and payroll source deduction
Two of the highest-risk areas in SMB tax due diligence are HST/GST remittances under the Excise Tax Act and payroll source deduction remittances. Directors are personally liable for unremitted source deductions under ITA s. 227.1 and for unremitted HST under Excise Tax Act s. 323. More importantly for a share purchase, these obligations belong to the corporation and thus transfer to the buyer’s investment. Confirm all payroll and HST accounts are current and that no arrears exist.
Employee vs. independent contractor classification
Many SMBs engage workers as independent contractors who the CRA would characterize as employees under the four-factor test from Wiebe Door Services Ltd. v. MNR [1986] 3 FC 553, which includes control, ownership of tools, chance of profit/risk of loss, and integration. A CRA reassessment reclassifying contractors as employees can trigger years of employer CPP contributions, EI premiums, and withholding tax, plus penalties and interest. In a share purchase, that reassessment risk transfers with the corporation.
Capital dividend account (CDA) and paid-up capital (PUC)
For post-closing planning purposes, confirm the corporation’s capital dividend account balance (which allows tax-free capital dividends to shareholders) and the paid-up capital of each class of shares (which determines how much a buyer can return to shareholders without triggering deemed dividends). These are important to any post-acquisition restructuring.
Tax attributes
Confirm non-capital loss carryforwards, capital loss carryforwards, and the corporation’s small business deduction eligibility and any associated corporation relationships that affect the $500,000 SBD limit. Review whether a holding company sits above the target and how the Opco-Holdco structure affects the purchase.
Legal and Corporate Due Diligence
Minute book review
The minute book is the legal record of the corporation’s history. Review the articles of incorporation (and all amendments), the bylaws, all director and shareholder resolutions, the share register and transfer ledger, share certificates, and any unanimous shareholders agreement (USA). Confirm that the directors and officers reflected in the CRA and government records match the minute book, that all share issuances and transfers are properly documented, and that the corporation has passed all required annual resolutions. A shareholders agreement, if one exists, must be reviewed carefully for change of control provisions, rights of first refusal, and drag-along rights that may affect the transaction.
Government and registry searches
Conduct searches to confirm the corporation’s good standing, registered address, and officer/director information at the applicable federal or provincial registry. In Ontario, search the Companies and Personal Property Security Branch for corporate status.
PPSA searches
The Personal Property Security Act, R.S.O. 1990, c. P.10 (PPSA), allows secured creditors to register security interests against a corporation’s personal property equipment, receivables, inventory, and all other assets under a General Security Agreement (GSA). Search the PPSA database against the target corporation’s legal name, trade names, and the names of any prior names the corporation has held. All registered security interests must be identified. In a share purchase, the buyer inherits any secured debt registered against the corporation. A condition of closing should include discharge of all PPSA registrations not being assumed.
Execution searches
Search for outstanding execution orders (court judgments being enforced) registered against the corporation. An outstanding execution can cloud title to assets and must be discharged before closing.
Contracts and change of control
This is often the most time-consuming legal workstream. Review all material contracts, key customer agreements, supplier contracts, licensing agreements, distribution arrangements, and service agreements for change of control clauses. In a share purchase, the change of hands of the target’s shares often triggers change of control provisions requiring consent from the counterparty before the contract can continue. Without that consent, the counterparty may have the right to terminate the agreement after closing. Identify every material contract that requires third-party consent and plan the consent-solicitation process as part of closing conditions.
Lease review
Commercial leases almost universally contain assignment and change of control provisions. Confirm the lease terms, renewal options, rent amounts, landlord consent requirements on a change of control, and any personal guarantee obligations. A buyer who closes a share purchase without addressing the lease may find the landlord entitled to terminate after closing.
Employment and labor
Review all employment agreements, particularly those with non-competition or non-solicitation clauses (post-employment restraints are narrowly enforced in Ontario under the Employment Standards Act, 2000, S.O. 2000, c. 41 and common law). The scope and duration must be carefully assessed. Identify any change-of-control bonuses, retention agreements, or severance entitlements triggered by the acquisition. Confirm whether any employees are unionized under the Labour Relations Act, 1995, S.O. 1995, c. 1. A collective agreement transfers with the business in both share and asset acquisitions under s. 69 of that Act. Confirm all source deduction remittances are current (cross-reference with tax DD).
Litigation and disputes
Request and review all outstanding litigation, regulatory proceedings, human rights complaints to the Human Rights Tribunal of Ontario, Ontario Labour Relations Board proceedings, and any threatened claims. Assess the quantum, likelihood, and insurance coverage for each. Unresolved litigation is typically addressed through a price holdback, an indemnity, or a closing condition requiring resolution.
Intellectual Property and Privacy Due Diligence
IP ownership
Confirm that the corporation, not the founder personally, not a prior holding company, actually owns the intellectual property that drives its value. This includes trademarks registered under the Trademarks Act, R.S.C. 1985, c. T-13 (search the Canadian Trademarks Database at cipo.ic.gc.ca), patents under the Patent Act, R.S.C. 1985, c. P-4, copyrights under the Copyright Act, R.S.C. 1985, c. C-42, and unregistered trade secrets, know-how, and proprietary processes. Where the IP was developed by employees, confirm that appropriate IP assignment provisions were in place in their employment agreements. Where it was developed by contractors, confirm IP assignment in the contractor agreements’ copyright, by default, it belongs to the creator, not the party that commissioned the work.
Privacy compliance
If the target holds personal information about customers, employees, or other individuals, review its compliance with the Personal Information Protection and Electronic Documents Act (PIPEDA), S.C. 2000, c. 5, and with Ontario’s Personal Health Information Protection Act, 2004, S.O. 2004, c. 3, Sched. A (PHIPA) if health information is involved. Identify any data breach incidents, privacy complaints, or investigations. Post-acquisition integration of customer data is a common compliance flashpoint.
IT systems and cybersecurity
Evaluate the scalability and condition of IT infrastructure, ERP and CRM systems, cloud service agreements, and cybersecurity posture. Identify whether the business uses licensed software that requires consent on change of control, and confirm whether any critical software is used without a proper license. A cybersecurity incident in the target’s history that has not been disclosed or remediated is a material liability.
Operational Due Diligence
Key-person risk
In many SMB acquisitions, the business’s revenue is substantially dependent on the owner-operator’s relationships, expertise, or public profile. Assess the depth of the management team below the owner, the degree to which customer relationships are transferable, and what retention arrangements, employment agreements, and consulting arrangements are needed to bridge the transition. Key-person dependency is one of the most common value-reduction findings in SMB due diligence and often drives a portion of the purchase price into an earnout rather than upfront cash.
Customer and supplier concentration
Identify the top ten customers by revenue and their proportion of total revenue. Confirm whether those relationships are contractual or relationship-based, and whether any customer contracts contain termination rights on a change of control. The same analysis applies to suppliers. single-source supply relationships represent a concentration risk that can become critical if the supplier relationship does not survive the acquisition.
Human resources and organizational structure
Review the headcount, compensation structure, benefit plans, and any outstanding HR issues (performance plans, harassment complaints, and accommodation requests). Confirm that the classification of full-time employees, part-time employees, and independent contractors is consistent with the legal requirements under the Employment Standards Act, 2000, and with the factual reality of those working relationships.
The Due Diligence Report and Its Role in Negotiating the Purchase Agreement
At the conclusion of due diligence, the buyer’s legal and financial advisers prepare a due diligence report that categorizes findings by severity. red flags (deal-killers or material price adjustments), yellow flags (issues requiring contractual protection or escrow), and accepted risks (identified issues the buyer is willing to live with at the agreed price). This report is the foundation of the purchase agreement negotiation.
Price adjustments
Material findings of undisclosed liabilities, inflated EBITDA, deferred capex, and pending litigation typically result in a price reduction or a restructuring of the consideration (more of the price deferred into an earnout or held back in escrow pending resolution).
Representations and warranties
The purchase agreement will contain extensive representations and warranties from the vendor about the state of the business that financial statements are accurate, that all taxes are paid, that there is no undisclosed litigation, that IP is owned by the corporation, and so on. Due diligence findings shape which representations are required, how broadly they are drafted, and what carve-outs the vendor will insist on in the disclosure schedules.
Indemnification
The indemnification provisions set out the vendor’s obligation to compensate the buyer for losses arising from a breach of representations and warranties. Key negotiated terms include the basket (a deductible below which individual claims are not compensable), the cap (the maximum aggregate liability, often 15–25% of the purchase price for SMB deals, with carve-outs for fundamental representations), and the survival period (how long after closing the representations remain actionable, typically 12 to 24 months for general representations, indefinitely for fundamental ones such as title and authority).
Representations and Warranties Insurance (RWI)
Increasingly available and cost-effective for SMB transactions, RWI allows the buyer to claim against an insurance policy rather than against the vendor directly for breaches of representations and warranties. This reduces the need for escrow or holdback provisions, provides a cleaner exit for the vendor, and gives the buyer a well-capitalized counterparty for post-closing claims. RWI is now common on deals above approximately $10 million and is making inroads into the $2–10 million range.
Closing conditions
Material due diligence findings often become closing conditions the buyer will not be obligated to close unless a specific condition is satisfied. Common closing conditions include receipt of third-party consents on key contracts and leases, discharge of PPSA registrations, resolution of outstanding litigation, and delivery of final financial statements confirming working capital at or above the peg.
Vendor Preparation. A Note on the Other Side
This article addresses due diligence from the buyer’s perspective. Vendors can significantly accelerate the process and protect deal value by preparing their records before going to market. A proactively assembled data room, a clean minute book, current tax filings, and organized contract records reduce the number of yellow flags that become price chips during buyer due diligence. We address vendor-side preparation in our companion article on selling a business in Ontario.
A thorough due diligence process is how buyers avoid inheriting problems they did not know existed and how they build the evidentiary record to negotiate a fair price and meaningful contractual protection. Missing a PPSA registration, overlooking an employee misclassification issue, or failing to identify a change-of-control clause in a key customer contract can cost more after closing than the deal was worth.
At Kalfa Law Firm, our M&A team guides buyers through the complete due diligence process, including corporate and legal review, contract analysis, PPSA, and execution searches employment and IP assessment and the negotiation of representations, warranties, and indemnities in the purchase agreement. We work alongside your accountants on financial and tax due diligence to ensure the legal and financial pictures are integrated before you commit.
If you are considering an acquisition or are currently in a due diligence process, contact us at (416) 631-7227 or book a consultation online. The time to identify a problem is before you close, not after.
FAQs
Ghazal Hamedani, Hons B.A., LL.B | Senior Associate
© Kalfa Law Firm , 2025. Updated September 17, 2026
The above provides information of a general nature only. This does not constitute legal advice. All transactions or circumstances vary, and specified legal advice is required to meet your particular needs. If you have a legal question you should consult with a lawyer.
