Financial and tax due diligence in Czech acquisitions: Why is thorough screening key to a safe company purchase?

When acquiring a company in the Czech Republic, the buyer must assess the condition of the target business and identify hidden risks that could jeopardise the return on investment. Financial and tax due diligence provide a complete overview of the company’s situation and help minimise transaction risks under Czech legislation. Without a thorough review, the investment can turn into a problem involving liability for undisclosed debts or outstanding tax liabilities.

Quick summary

• Due diligence is essential prevention: A thorough financial and tax review before acquiring a company is considered a standard part of the M&A process in the Czech Republic and protects you from losses arising from unknown liabilities and risks.
• Financial risks can be measured and mitigated: Hidden debts, uncollectible receivables, missing provisions, or accounting issues can be identified and then resolved, or reflected in a purchase price reduction.
• Tax risks are long-term in nature : Incorrectly filed tax returns, missing VAT deductions, or non-compliance with rules on the use of tax losses may be assessed retroactively under Czech tax legislation.
• Complexity requires professionals : Each step contains details and links to other legal areas, which is why handling the process through specialists from ARROWS, a Prague-based law firm, is safer.

Due diligence as a strategic tool to protect your investment

When purchasing a company or part of it, both sides of the transaction operate under uncertainty, because the seller has information about the company while the buyer does not. This information asymmetry creates room for hidden risks that may exist without the new owner’s knowledge. The purpose of due diligence is to review the legal, financial, and tax position of the business and identify any potential risks.

From a legal perspective, it is a fundamental tool for risk management and proper valuation of the transaction under Czech law. Without it, an apparently advantageous acquisition can quickly turn into a financial disaster. Case law of Czech courts confirms that conducting due diligence before acquiring a business is one of the prerequisites for fulfilling the duty of members of a statutory body to act with due managerial care.

The due diligence process is properly structured and begins with the seller making documentation available via a secure virtual repository (Data Room). Based on these materials, the buyer carries out a thorough assessment, the output of which is a written report containing a risk analysis.

Cooperation between the individual specialist teams is important, and the attorneys at ARROWS, a Prague-based law firm, routinely coordinate it. In practice, legal, financial, and tax due diligence are most often combined, with the scope of the review depending on the sector and the size of the business.

Related questions about the due diligence process

1. What is the exact due diligence timeline?
Due diligence usually starts immediately after signing a preliminary agreement and typically takes 4–12 weeks, depending on the size and complexity of the company. During this period, documents are analysed, checks are carried out, and meetings with management take place.

2. Who should conduct due diligence?
Due diligence can be carried out by the buyer in-house; however, given the liability and expertise required, in practice an external team of specialists is preferred—attorneys, auditors, and tax advisers. They bring objectivity, professional liability insurance, and experience from many similar transactions in the Czech Republic.

3. Can due diligence also be carried out on the seller’s side?
Yes, sellers increasingly commission so-called Vendor Due Diligence (VDD). This is a review initiated by the seller to identify and address problematic areas before the buyer discovers them, which significantly speeds up the subsequent sale process.

Financial due diligence: uncovering hidden financial risks

Financial due diligence focuses on a detailed analysis of the accounting, financial statements, assets, and liabilities of the target company. It is a review intended to answer key questions about the company’s real financial health and the existence of hidden debts.

Common findings from a financial review include the omission of potential liabilities that may arise from litigation. It also often involves receivables that are uncollectible, or failures to comply with the company’s statutory obligations under Czech legislation, which auditors must identify and assess.

The difference between a statutory audit and financial due diligence is that an audit verifies that the accounts present a true and fair view as of a date in the past. Due diligence, by contrast, focuses on the sustainability of results, EBITDA normalisation, and the company’s future development.

Most common financial issues in acquisitions

When acquiring a company, the buyer encounters a range of risks, such as overdue receivables, poorly structured loans, or overvalued assets. Proper record-keeping and thorough financial analysis should prevent disorder in the finances.

A potential buyer should look into whether the company has loans and under what terms it repays them. It is also necessary to verify the existence of so-called covenants and overdue liabilities.

Another risk is uncollectible receivables, where enforcement is ineffective due to the debtor’s insolvency. In the accounts, such risks should be reflected through allowances; otherwise, the company presents a distorted picture of its assets.

Without a cash flow analysis, you could acquire a company that is profitable on paper but lacks funds for wages or to settle its liabilities. In practice, we often encounter situations where a company shows a profit on paper but in reality has serious cash flow problems.

Assets and their valuation

The company’s assets must be correctly recorded in the accounts, so when reviewing real estate or inventory it is crucial to verify the reality of their book value. A common issue is incorrect distinction between repairs and technical improvements, which affects the tax base under Czech tax rules.

A specific risk arises with real estate if the price is not properly allocated between the value of the building and the land, leading to incorrect depreciation. If you are acquiring a company with significant assets, it is advisable to arrange an independent valuation or technical inspection.

Accounting and documentation – hidden errors

Proper accounting is a statutory obligation, and neglecting it can lead to significant penalties. If a company does not publish its financial statements, it faces, under the Accounting Act, a fine of up to 6% of the value of its total assets.

For a new owner, it is difficult to trace historical data if documentation is missing. As part of the financial and tax review, historical periods are therefore reviewed, usually 3 to 5 years back, and longer in justified cases.

Risks and sanctions	How ARROWS can help (office@arws.cz)
Hidden and contingent liabilities: Liabilities from litigation or guarantees that are not shown on the balance sheet.	ARROWS conducts an analysis of legal documents and contracts to identify off-balance-sheet risks, which we then address in the transaction documentation.
Uncollectible receivables: The company reports receivables as sound even though they are unenforceable.	We will help assess the risk profile of the receivables structure and propose an adjustment of the purchase price for uncollectible items.
Incorrect asset valuation: Incorrect depreciation or failure to distinguish capital improvements.	We will ensure a review of title and ownership relationships and, in cooperation with tax advisors, verify the correctness of the depreciation policy under Czech tax rules.
Lack of documentation: Missing contracts or accounting records and the risk of sanctions.	We identify missing documentation and ensure remediation or completion as part of the conditions precedent to closing the transaction.

Tax due diligence: Hidden risks in the Czech tax system

Tax due diligence reviews compliance with tax obligations and identifies the risk of additional tax assessments, penalties and late-payment interest. It focuses primarily on corporate income tax and VAT in the Czech Republic, but for specific entities also on other taxes.

Main areas of a tax review

Tax due diligence uncovers risks and quantifies their financial impact. The review focuses in particular on the accuracy of tax returns, the existence of arrears, transfer pricing settings, the application of VAT deductions and the use of investment incentives under Czech legislation.

The result is a risk overview (Red Flag Report), which serves as a basis for negotiating a purchase price reduction. This report also helps when defining specific warranties in the share purchase agreement.

Transfer pricing – a frequently overlooked risk

One of the riskiest aspects for group-connected companies is transfer pricing. Prices agreed between related parties must correspond to prices that would be agreed between independent entities in ordinary commercial relationships.

If prices differ from market levels and the difference is not satisfactorily documented, the Czech tax authority will assess the difference, including penalties. Transfer pricing has long been under scrutiny by the Czech Financial Administration, and late-payment interest can reach significant amounts.

The solution is to have high-quality transfer pricing documentation prepared (Master File and Local File). Although Czech law does not strictly prescribe a mandatory form of this documentation for all entities, without it, defending the position before the Czech tax office is extremely difficult.

VAT and its complexity

Value added tax is an area with frequent errors, and it is necessary to verify the legitimacy of VAT deduction claims. It is also important to check the correct reporting of cross-border supplies.

Risk areas include the defensibility of input VAT deduction claims on received supplies and the correct determination of the place of supply for services. It is also necessary to review liability for unpaid tax by a supplier, i.e., the Czech “unreliable VAT payer” regime.

Tax deficits from previous periods

The standard limitation period for assessing tax is 3 years, but it may be extended up to 10 years. If you acquire a company with a hidden historical tax liability, the Czech tax office will enforce the tax against that company—effectively against your new investment in the Czech Republic.

Related questions regarding a tax review

1. What period does tax due diligence cover?

As a standard, tax periods are reviewed for which the limitation period for assessing tax (the preclusive period) has not yet expired. Typically, this is the last 3 to 4 years; for companies with tax losses or investment incentives, it may be longer (up to 8–10 years) under Czech tax rules.

2. Can tax risks be addressed after acquiring a company?

Yes, primarily contractually—through representations and warranties (R&W) and an indemnity undertaking in the share purchase agreement. If the Czech tax office assesses additional tax for a period prior to the transfer, the seller is obliged to compensate the buyer for the loss.

Due diligence process in practice: From data collection to conclusions

The due diligence process requires a systematic approach, with the first step being the preparation of a list of requested documents (Request List). This list is always tailored to the relevant industry and the specifics of the transaction.

Preparation and the Data Room

The seller or its advisors will prepare a Data Room, which is a secure electronic repository for uploading contracts and reports. Access to this repository is managed and monitored to ensure the confidentiality of information.

Experts from ARROWS, a Prague-based law firm, routinely work with virtual data rooms, ensuring efficiency, data security and a clear process.

Q&A and management presentations

After reviewing the documents, the Q&A phase follows, during which the buyer’s advisors ask follow-up questions to clarify uncertainties. This often includes interviews with key managers, which help to understand the business model and strategy.

Analysis and evaluation (Red flag report)

The output is not merely a description of the status, but above all the identification of risks categorized by severity. The report typically classifies findings into deal breakers, high-risk areas requiring indemnification, and less serious risks that can be managed in the ordinary course of business.

Change of control and its consequences

A significant risk involves change of control clauses, which give the counterparty the right to terminate the contract in the event of a change of ownership. These contractual provisions may also lead to a requirement for immediate repayment of debt.

Where these clauses occur

Change of control clauses are typical in loan agreements, where banks reserve the right to accelerate the loan. They also occur in contracts with key suppliers, in lease agreements in premium locations, or in licence agreements.

Practical solution

The ARROWS team, a Prague-based law firm, systematically searches for these provisions as part of legal due diligence. If identified, it is necessary to obtain written consent from the affected partners before closing the transaction, or to arrange refinancing of the loans.

Risk	ARROWS solution (office@arws.cz)
Termination of key contracts: Loss of a critical customer or supplier after a change of ownership.	We identify high-risk contracts and assist in obtaining partners’ consent (Consent/Waiver) before signing the share purchase agreement.
Loan acceleration (cross-default): Immediate maturity of debts owed to banks.	We will help set refinancing conditions or negotiate the continuation of financing with the new owner.

Legal due diligence: The fundamentals of a safe acquisition

Legal due diligence focuses on verifying the company’s valid existence, ownership of shares/ownership interests, and contractual relationships. The aim is to confirm that the company operates without legal defects under Czech law and that there are no obstacles to its transfer in the Czech Republic.

Key areas of legal review

• Corporate history : Verification that the company was duly incorporated and that all historical transfers of shares/ownership interests were valid.
• Ownership of shares/ownership interests : Review of the chain of title.
• Employment law : Agreements with key employees and non-compete clauses.
• Intellectual property (IP): Verification of copyright to software and licensing arrangements.
• Litigation : Analysis of ongoing and threatened proceedings in Czech courts.

Historical defects in ownership

A key risk is the invalidity of historical transfers of shares/ownership interests, for example due to missing approval of the general meeting. In such a case, the seller may not be the true owner, and it may be necessary to rely on the Czech legal concept of acquisitive prescription (adverse possession) or to arrange special insurance.

Seller warranties and their role in transactions

The results of due diligence are directly reflected in the share purchase agreement in the form of representations and warranties. These mechanisms serve to allocate risk between the buyer and the seller under Czech law.

Representations & Warranties

In the purchase agreement, the seller represents that the company has certain characteristics—for example, that it has no outstanding tax liabilities in the Czech Republic. If the opposite proves to be true, the buyer becomes entitled to a price reduction or damages.

Indemnities – direct compensation

For specific identified risks, such as an ongoing tax audit, so-called Indemnities are agreed. Here, the seller undertakes to reimburse the buyer for every Czech crown of loss arising from the given risk.

Disclosure Letter

The seller is released from liability by informing the buyer of defects in a so-called Disclosure Letter. As a rule, the seller is not liable for what is disclosed there, because the buyer was aware of the risk.

Employees and employment-law aspects

In a share transfer, the employer remains the same, whereas in an asset/business sale there is an automatic transfer of rights and obligations. This process is governed by the Czech Labour Code and protects employees from a deterioration of their terms and conditions.

Information obligation

The Czech Labour Code imposes an obligation to inform employees about the transfer and to discuss its consequences with them sufficiently in advance. A breach of this obligation may result in sanctions imposed by the Czech Labour Inspectorate of up to CZK 200,000.

Earn-out and transaction insurance

If the parties cannot agree on the price, an earn-out is used, where part of the purchase price is paid later. The condition is that the company achieves the specified financial targets in the following years, typically within a one- to three-year period.

In modern transactions, W&I insurance (Warranty & Indemnity Insurance) is increasingly used. In the event of a breach of the seller’s warranties, the loss is not paid by the seller but by the insurer, enabling a clean exit for the seller.

Conclusion

Financial and tax due diligence is a complex process requiring expertise. Neglecting this phase may lead to fatal losses and personal liability of management.

Our Czech legal team at ARROWS advokátní kancelář can identify risks, propose solutions, and reflect them in the contractual documentation. We have experience from many transactions and will ensure that your investment is protected in the Czech Republic.

If you are planning an acquisition, do not take unnecessary risks—turn to professionals. Contact us at office@arws.cz for a non-binding consultation regarding your plans.

Notice: The information contained in this article is of a general informational nature only and is intended for basic guidance on the topic. Legal regulations and their interpretation evolve over time. To verify the current wording of the regulations and their application to your specific situation, it is necessary to contact ARROWS advokátní kancelář directly.

Read also:

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• Liquidating an Inactive Czech Company in 2026: Procedure and Tax Risks
• Business Dissolution and Insolvency: Legal Strategies for Companies in Czechia
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