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Every business acquisition involves a period of investigation, a time when the prospective buyer looks beneath the surface of the target company to understand what it is actually being purchased. That investigation, commonly referred to as due diligence, covers financials, operations, contracts, legal exposure, and a range of other variables that can affect the value and viability of the deal. While the broad strokes of due diligence are similar from state to state, the details matter enormously, and the details in Texas are shaped by a legal and regulatory environment that is distinct from what buyers may encounter elsewhere.
Texas has no personal or corporate income tax. It has a franchise tax calculated on business margins. Its employment laws follow at will principles with unique provisions around non compete agreements. Its entity formation rules are governed by the Texas Business Organizations Code, and its environmental regulatory landscape is overseen by the Texas Commission on Environmental Quality rather than by the EPA alone. Each of these features, and many others, creates specific due diligence questions that a buyer should address before signing a purchase agreement.
The Law Offices of Alan Abergel, P.C. works with clients dealing with disputes that emerge after a business transaction has closed, situations where due diligence either missed a critical issue or where representations made during the deal turn out to have been inaccurate. This article walks through the key areas of due diligence that are particularly important when the target company operates in Texas.
The starting point for any acquisition is confirming that the target entity actually exists in good standing under the laws of its state of formation. In Texas, business entities are formed and maintained under the Texas Business Organizations Code (TBOC), and the Texas Secretary of State’s office maintains the official records of entity formation, amendments, mergers, and terminations. The Secretary of State’s SOSDirect portal at www.sos.state.tx.us/corp/sosda/index.shtml allows anyone to search for an entity and verify its current status.
A buyer should confirm that the target’s certificate of formation is current, that all required amendments have been properly filed, and that the entity has not been involuntarily terminated or had its right to transact business forfeited. Forfeiture is a real risk in Texas. Under the Texas Tax Code, the Comptroller of Public Accounts can forfeit an entity’s right to transact business if it fails to file its franchise tax reports or pay its franchise tax obligations. When an entity’s right to transact business has been forfeited, it loses the ability to sue or defend itself in Texas courts, and its directors and officers can become personally liable for the entity’s debts. This is not a theoretical concern, it happens with some frequency, and discovering that a target entity has been forfeited after closing can create serious complications for the buyer.
The buyer should also review the target’s governing documents. The certificate of formation and the bylaws (for a corporation) or the company operating agreement (for an LLC)—to understand the entity’s internal governance structure, the allocation of management authority, any restrictions on the transfer of ownership interests, and any provisions that might require consent or approval from other parties before the transaction can close. Under the TBOC, these documents can be highly customized, and Texas law gives significant weight to the terms that the parties have agreed to in their governing documents.
Texas does not impose a personal income tax or a traditional corporate income tax. Instead, it imposes a franchise tax sometimes called a margin tax on most entities that do business in the state. The franchise tax is codified in Chapter 171 of the Texas Tax Code, and the Texas Comptroller of Public Accounts administers the tax and maintains filing resources at comptroller.texas.gov/taxes/franchise.
For due diligence purposes, the franchise tax raises several important questions. First, the buyer needs to confirm that the target has filed all required franchise tax reports and paid all franchise tax, penalties, and interest. Failure to stay current on franchise tax obligations can result in forfeiture of the entity’s right to transact business, as discussed above, and it can also block the filing of merger or termination documents with the Secretary of State. Before any entity can merge out of existence or terminate its registration in Texas, it must either obtain a Certificate of Account Status from the Comptroller confirming that all tax obligations have been satisfied, or include a statement in the merger filing that the surviving entity will be responsible for the franchise tax obligations. The Comptroller’s office maintains guidance on this process at comptroller.texas.gov/taxes/franchise/reinstate-terminate.php.
Second, buyers should evaluate whether the target has been calculating its franchise tax correctly. The franchise tax is computed on an entity’s “taxable margin,” which is total revenue minus certain deductions either cost of goods sold, employee compensation, or a standard 30% deduction. Entities with total revenue at or below $2.47 million owe no franchise tax, and entities earning under $20 million can elect the simplified EZ Computation method. However, entities that are part of a combined group must calculate the no-tax-due threshold based on the combined group’s total annualized revenue, not the individual member’s revenue. A buyer acquiring a company that will become part of the buyer’s combined group needs to understand how the acquisition will affect the group’s overall franchise tax position.
Third, buyers should be aware of successor liability for franchise tax. Under Section 111.020 of the Texas Tax Code, a purchaser of a business may become liable for the seller’s unpaid state taxes including franchise tax and sales tax unless the buyer obtains a tax clearance certificate from the Comptroller before closing. The Comptroller has 90 days to respond to a request for a clearance certificate, and if no response is issued within that window, the buyer is generally released from successor liability for pre closing tax obligations. This is a critical procedural step that should be incorporated into every Texas acquisition timeline.
Texas imposes a state sales tax of 6.25% on most retail sales, leases, and rentals of tangible personal property, as well as on certain taxable services. Local jurisdictions cities, counties, transit authorities, and special purpose districts can impose an additional sales tax of up to 2%, bringing the maximum combined rate to 8.25%. Businesses that sell taxable items or services in Texas must hold a Texas Sales and Use Tax Permit, collect the appropriate tax from their customers, and remit it to the Comptroller.
From a due diligence standpoint, the buyer should verify that the target has been collecting and remitting sales tax properly. Uncollected or under-remitted sales tax creates a direct liability for the business, and in an asset acquisition, that liability can follow the assets to the buyer under the Texas Tax Code’s successor liability provisions. The buyer should request copies of the target’s sales tax returns, review any audit history with the Comptroller, and evaluate whether the target has been correctly identifying which transactions are taxable and which are exempt. Certain items such as manufacturing machinery and equipment, and research and development materials may qualify for sales tax exemptions under Texas law, but claiming those exemptions requires proper documentation.
The buyer should also evaluate whether the target has use tax obligations. Use tax applies when a business purchases taxable goods or services without paying sales tax for example, when purchasing equipment from an out-of-state vendor that does not collect Texas sales tax. Many businesses overlook use tax obligations, creating hidden liabilities that a buyer can inherit.
Texas is an at will employment state, meaning that either the employer or the employee can terminate the employment relationship at any time, for any reason that is not prohibited by law, and without notice. There is no general requirement under Texas law for employers to provide severance pay, advance notice of termination, or a specific reason for termination. This framework gives Texas employers significant flexibility, but it does not eliminate employment related risk in an acquisition.
A buyer should review the target’s employee roster and pay practices to evaluate compliance with the federal Fair Labor Standards Act (FLSA) and the Texas Payday Law, codified in Chapter 61 of the Texas Labor Code. The Texas Payday Law establishes requirements for the timing and method of wage payments and provides remedies for employees who are not paid in accordance with their employment agreement. The Texas Workforce Commission (TWC) administers and enforces the Payday Law and maintains guidance at www.twc.texas.gov. Claims under the Payday Law—as well as wage and hour claims under the FLSA can represent meaningful liabilities that a buyer may inherit if they are not identified during due diligence.
Worker classification is another area that requires careful examination. Texas, like most states, distinguishes between employees and independent contractors, and the distinction affects tax withholding obligations, workers’ compensation requirements, and eligibility for unemployment insurance. The TWC uses a multi-factor test to determine whether a worker is an employee or an independent contractor for purposes of unemployment tax liability. A company that has been misclassifying workers as independent contractors may face back taxes, penalties, and interest from both the TWC and the Internal Revenue Service. For a buyer, discovering misclassification issues after closing can result in unexpected liabilities and the need to restructure the target’s workforce arrangements.
In many acquisitions, a significant portion of the target company’s value lies in its workforce, the knowledge, relationships, and skills of its key employees. Buyers frequently seek to ensure that those employees will remain with the company after closing and that they will not leave to compete against the business. This makes the enforceability of non compete agreements and other restrictive covenants a critical due diligence item.
Texas law on non compete agreements is governed by the Covenants Not to Compete Act, codified in Section 15.50 of the Texas Business and Commerce Code. Under the Act, a non-compete is enforceable if it is ancillary to or part of an otherwise enforceable agreement, contains limitations as to time, geographical area, and scope of activity that are reasonable, and does not impose a greater restraint than is necessary to protect the goodwill or other business interest of the party benefiting from the restriction.
For buyers, the due diligence question is twofold. First, do the target’s existing non compete agreements with key employees and executives meet the enforceability standards under Texas law? If those agreements were poorly drafted lacking adequate consideration, or containing overly broad geographic or temporal restrictions they may not survive a challenge in court, leaving the buyer without the protections it assumed it was purchasing. Second, will those agreements survive the change of ownership? Depending on how the acquisition is structured, existing employment agreements may or may not carry over to the new owner, and additional agreements or amendments may be needed to preserve the buyer’s protections.
Notably, an important exception exists for non compete agreements entered into in connection with a bona fide sale of a business. Both under current Texas law and under proposed federal legislation (such as the FTC’s now-vacated non-compete rule), non competes tied to the sale of a business or ownership interests receive more favorable treatment than employment based non competes. A buyer should confirm that the seller’s non-compete is properly tied to the transaction and meets the requirements for this exception.
Environmental liability is a major due diligence concern in any acquisition, and Texas’s industrial and energy intensive economy makes it particularly important here. The Texas Commission on Environmental Quality (TCEQ) is the state’s primary environmental regulatory agency, responsible for administering and enforcing environmental laws related to air quality, water quality, waste management, and the remediation of contaminated sites. The TCEQ maintains its public database and regulatory resources at www.tceq.texas.gov.
A buyer acquiring a Texas-based business, particularly one that involves manufacturing, oil and gas operations, chemical processing, waste handling, or any activity that generates emissions, effluent, or hazardous waste should conduct a thorough review of the target’s environmental compliance history. This includes reviewing all TCEQ permits held by the target, any history of environmental enforcement actions or consent orders, any open or pending notices of violation, and any past or ongoing remediation obligations. The buyer should also evaluate whether the target’s operations are in compliance with the federal Clean Air Act, Clean Water Act, and Resource Conservation and Recovery Act (RCRA), as well as the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), also known as the Superfund law.
Phase I and Phase II Environmental Site Assessments are standard tools in environmental due diligence. A Phase I assessment involves a review of historical records, site inspections, and regulatory database searches to identify recognized environmental conditions. If the Phase I identifies potential contamination, a Phase II assessment involves physical sampling and laboratory analysis to confirm the presence and extent of contamination. Under CERCLA, the “innocent landowner” defense and the “bona fide prospective purchaser” defense both require the buyer to have conducted “all appropriate inquiries” prior to acquiring the property—and conducting a Phase I assessment that meets the ASTM E1527 standard is the accepted way to satisfy that requirement.
Texas also has its own state-level voluntary cleanup program, administered by the TCEQ, which allows property owners to address contamination under regulatory oversight and obtain a certificate of completion that can provide a degree of liability protection. A buyer should determine whether the target or any of its properties are enrolled in or have completed the TCEQ’s Voluntary Cleanup Program (VCP), and should evaluate what liability protections, if any, those certificates provide.
Texas does not have a state level property tax, but local taxing authorities including counties, cities, school districts, and special districts rely heavily on property taxes as a source of revenue. As a result, ad valorem property taxes in Texas can be significant, and the buyer should evaluate the target’s current property tax obligations as part of the due diligence process.
Every business that owns tangible personal property used in the production of income such as equipment, furniture, fixtures, and inventory must file an annual property tax rendition with the county appraisal district where the property is located. The rendition is a report that lists the property and its value. Failure to file renditions, or filing renditions that significantly understate the value of the property, can result in penalties and can expose the buyer to back-tax liability. The buyer should review the target’s rendition history and compare the reported values against the target’s actual asset inventory.
If the acquisition involves real estate, the buyer should also evaluate any existing property tax abatement agreements, which are incentive agreements between a taxing authority and a property owner that reduce or eliminate property taxes for a specified period in exchange for capital investment or job creation commitments. These agreements are common in Texas economic development deals, and the buyer needs to understand whether the abatement will survive the change of ownership and what conditions the buyer must satisfy to maintain the abatement. The Texas Comptroller’s office and the Texas Economic Development Corporation at businessintexas.com provide information on state and local incentive programs.
A review of the target’s litigation history and current legal exposure is a core component of any acquisition due diligence process, and Texas presents some unique considerations in this area. Texas is one of the largest and most active litigation jurisdictions in the country, with a court system that includes district courts of general jurisdiction, county courts, and as of September 2024 the new Texas Business Court, a trial level court designed to handle complex commercial disputes.
The buyer should search for pending lawsuits involving the target in all relevant jurisdictions, including Texas state courts, federal courts in the Northern, Southern, Eastern, and Western Districts of Texas, and the Texas Business Court. The buyer should also evaluate any administrative proceedings pending before state agencies, including the TWC, the TCEQ, the Texas Department of Insurance, and any industry-specific regulatory bodies. Claims that may seem minor on paper such as a single wage complaint or a notice of environmental violation can signal broader compliance failures that warrant deeper investigation.
Texas law also includes specific provisions that can affect the buyer’s litigation exposure after closing. In an asset purchase, the general rule under Texas law is that the buyer of a business’s assets is not liable for the seller’s debts or liabilities unless the buyer expressly assumes them. However, exceptions to this rule exist including where the transaction amounts to a de facto merger, where the buyer is a mere continuation of the seller, or where the transaction was fraudulently structured to escape liability. Section 10.254 of the TBOC provides that a disposition of all or part of the property of a domestic entity is not a merger or conversion for any purpose, and a person acquiring property under this section is not liable for obligations of the transferring entity that are not expressly assumed. Understanding how these rules interact with the specific transaction structure is essential for managing post-acquisition liability risk.
Texas’s economy spans a wide range of heavily regulated industries, and a buyer must verify that the target holds all licenses, registrations, and permits required to conduct its business. The specific regulatory requirements depend on the industry. Companies in the energy sector may need permits from the Railroad Commission of Texas, which regulates oil and gas production, pipeline safety, and surface mining. Healthcare businesses may need licenses from the Texas Health and Human Services Commission or the Texas Medical Board. Financial services companies may be subject to oversight by the Texas Department of Banking, the Texas Department of Insurance, Texas SML, TSSB, TX SOS, or the Office of Consumer Credit Commissioner (OCCC).
The buyer should determine whether the target’s licenses, registrations, and permits are transferable to a new owner or whether the change of ownership will require new applications, amendments, approvals, or notifications. In many cases, a change of control triggers a requirement to notify the licensing agency and obtain its consent, and failure to do so can jeopardize the license itself. The Texas Department of Licensing and Regulation (TDLR) oversees a wide range of occupational licenses and maintains its license search and regulatory information at www.tdlr.texas.gov. For businesses that depend on their licenses to operate, this is not a step that can be deferred until after closing.
Intellectual property frequently represents a substantial portion of the value in a business acquisition, and Texas law provides a specific framework for the protection of trade secrets that the buyer should understand. The Texas Uniform Trade Secrets Act (TUTSA), codified in Chapter 134A of the Texas Civil Practice and Remedies Code, defines a trade secret broadly as information including formulas, patterns, compilations, programs, devices, methods, techniques, or processes that derives independent economic value from not being generally known and is the subject of reasonable efforts to maintain its secrecy.
During due diligence, the buyer should evaluate whether the target has taken adequate steps to protect its trade secrets, including through confidentiality agreements with employees and contractors, physical and electronic access controls, and internal policies governing the handling of sensitive information. If the target’s trade secret protections are weak, those assets may be at risk of loss or misappropriation and the buyer’s ability to enforce trade secret claims after closing may be limited. The buyer should also review the target’s trademark registrations with the U.S. Patent and Trademark Office and the Texas Secretary of State, patent filings, copyright registrations, and any licensing agreements that grant third parties rights to use the target’s intellectual property.
Since January 1, 2024, the federal Corporate Transparency Act (CTA) has imposed beneficial ownership reporting requirements on many domestic entities, including most Texas LLCs and corporations. Companies that are required to report must file a Beneficial Ownership Information (BOI) report with the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury. FinCEN maintains its BOI filing guidance at www.fincen.gov/boi.
For acquisition due diligence, the CTA is relevant in two ways. First, the buyer should verify that the target has filed its required BOI report and that the information in the report is accurate. Failure to file, or filing inaccurate information, can result in civil and criminal penalties. Second, the buyer should evaluate how the acquisition itself will affect the target’s reporting obligations. A change in ownership may require an updated BOI filing within 30 days, and the buyer should plan for this as part of the post-closing integration process.
Acquiring a Texas based business offers significant potential advantages: access to a large and diversified economy, a favorable tax structure, a modern statutory framework under the TBOC, and a legal environment that has been actively modernized through recent legislation like Senate Bill 29 and the establishment of the Texas Business Court. But those advantages do not eliminate the need for thorough, Texas specific due diligence.
The topics covered in this article entity verification, franchise tax compliance, sales and use tax exposure, employment law issues, non compete enforceability, environmental liability, property tax obligations, pending litigation, regulatory licensing, intellectual property, and the Corporate Transparency Act represent areas where the Texas legal landscape creates questions that a buyer may not encounter in other states, or where the answers differ from what the buyer might expect based on experience in other jurisdictions. A methodical approach to each of these areas can help surface risks early, inform the deal structure, and strengthen the buyer’s position in negotiating representations, warranties, and indemnification provisions.
The Law Offices of Alan Abergel P.C.'s law practice includes matters arising from business acquisitions and corporate transactions. If you are a defendant facing a dispute related to an acquisition of a Texas based business whether it involves misrepresentations, undisclosed liabilities, or other post closing claims we welcome the opportunity to discuss how we may be able to assist
Disclaimer:
This article is provided for informational purposes only and does not constitute legal advice. Reading this article does not create an attorney-client relationship. Every legal situation is unique, and results depend on the specific facts and circumstances involved. If you have questions about a particular legal matter, you should consult with a qualified attorney.
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