Navigating Tax Risks in M&A Deals: A CFO’s Insight

Mergers and acquisitions are not closed by vision alone. They are closed in data rooms, diligence checklists, and quiet Excel models buried beneath layers of assumptions. As a CFO who has supported numerous venture-backed companies through Series A to D growth trajectories, I have witnessed promising deals falter not because of market shifts or valuation gaps, but because of poorly managed tax positions. Particularly, deferred tax exposures—those items that seemed innocuous in early years—resurface with sharp consequences when M&A activity accelerates.

Many founders and boards underestimate how deeply tax considerations influence acquisition strategy. They focus on strategic fit, customer overlap, and valuation optics. But tax, when neglected, can quickly become the silent veto. It is the unspoken reason behind extended diligence cycles, price reductions, escrow holds, and, in some cases, deal abandonment. Deferred tax liabilities, especially those tied to net operating losses (NOLs), state and local compliance, sales tax exposure, and employee equity mismanagement, frequently sit at the center of this hidden turbulence.

This essay lays out how companies can preempt tax surprises that can threaten deal viability. It draws from real-world experience in preparing companies for exit, articulates the most commonly overlooked exposures, and offers practical approaches to surfacing and resolving risks before the buyer finds them.

Deferred Taxes Are Not Just an Accounting Entry

In financial statements, deferred taxes often appear as abstract numbers—assets and liabilities based on timing differences between book and tax recognition. But in a transaction, they transform from theory to reality. Buyers will scrutinize deferred tax positions to evaluate future obligations and cash flow impact. And if the calculations are inaccurate or unsupported, they demand adjustments.

Startups that have not carefully tracked depreciation schedules, R&D capitalization policies, or revenue deferral methods often carry deferred balances that are mathematically plausible but practically unsubstantiated. During diligence, acquirers dig into fixed asset ledgers, examine expense recognition policies, and question differences between GAAP and IRS filings. If discrepancies arise, trust erodes.

I supported a transaction where the seller had over-reported deferred tax assets tied to NOLs that were, in fact, subject to severe limitations under Section 382 due to prior equity changes. The buyer adjusted the purchase price downward by 7% to reflect the unusable tax shield. The founders hadn’t intended to misrepresent the value. They simply didn’t realize the accounting view was materially overstated. That knowledge gap cost them both capital and negotiating power.

Tax diligence is not a ceremonial exercise. It is a forensic one. Companies that prepare for this reality in advance strengthen their position and reduce post-close exposure.

Sales Tax Is the Most Common and Most Avoided Risk

Among all tax exposures, sales tax creates the most frequent and overlooked disruptions. Particularly in SaaS, ecommerce, and services businesses, the complexity of state-by-state rules makes sales tax compliance a minefield. Nexus—the threshold that creates an obligation to collect and remit taxes—can be triggered by something as simple as a remote employee or a digital download.

The 2018 Wayfair decision expanded state authority to impose economic nexus, even in the absence of physical presence. Startups that operate nationally but register in only one state are often noncompliant in dozens of others. This noncompliance is rarely detected until an acquirer’s diligence team performs a nexus study. And when they do, the results can be deal-altering.

In one case, a client discovered mid-transaction that it had sales tax exposure in eight states, spanning three years. The acquiring company requested voluntary disclosure agreements (VDAs) be filed, delayed closing by six weeks, and demanded an escrow large enough to cover potential liabilities. The founder described the experience not as punitive, but humiliating. It was a reminder that compliance isn’t optional simply because it’s complex.

Startups should evaluate their sales tax exposure annually and, if needed, engage advisors to model obligations and pursue remediation. The cost of early resolution is often negligible compared to the cost of last-minute correction.

NOLs Are an Asset—Until They Are Not

Net operating losses are a powerful tax attribute, allowing companies to offset future taxable income with past losses. On the balance sheet, they are carried as deferred tax assets. But in the context of M&A, their usability is far from guaranteed.

IRS Section 382 imposes limitations on the use of NOLs when there has been an ownership change—defined by changes in equity ownership that cross certain thresholds. Most startups trigger 382 limitations multiple times during funding rounds, especially if investors take large preferred stakes. If not monitored, the result is that NOLs become functionally useless, despite being listed on financial statements.

During diligence, buyers conduct detailed analyses of equity issuances, investor rights, and capital changes to assess whether Section 382 has been triggered. If it has, and the company has not properly adjusted its deferred tax assets, the buyer will reduce the purchase price accordingly.

The solution is not to avoid NOLs, but to manage them properly. This includes maintaining clear cap table records, modeling Section 382 implications after each financing round, and ensuring tax filings reflect these realities. Founders who can explain the exact value of their NOLs—what is usable, what is limited, and why—earn credibility and preserve leverage.

Equity Incentives Can Trigger Unexpected Liabilities

Another area ripe for tax surprises is employee equity. Stock options, RSUs, and other equity-linked compensation tools create not just alignment, but tax complexity. When administered poorly, they create deferred liabilities for both the company and its employees.

Poorly timed option grants, outdated 409A valuations, or unapproved equity plans can all invite scrutiny. If an acquirer identifies unrecognized compensation expenses or improper tax withholdings, they may require a gross-up to protect employees or delay closing until liabilities are resolved. In some cases, founders may be required to restructure their own equity for the deal to proceed.

I’ve reviewed transactions where last-minute discoveries about ISO disqualifications or failed 83(b) filings required reissuance of grants and adjustment of financials. None of these issues were malicious. They were the byproducts of growth without governance.

To mitigate these risks, startups should periodically review their equity plans with tax counsel, reconcile grant activity with cap table data, and proactively educate employees on the tax implications of their awards. In exit scenarios, this preparation shortens diligence cycles and reduces buyer friction.

International Operations Multiply Exposure

As startups expand globally—through hiring, contracting, or customer acquisition—they often create unintentional permanent establishments, which can trigger foreign income tax, VAT, or employment-related liabilities. In early stages, the impact may be limited. But in an acquisition scenario, these liabilities are uncovered quickly.

I’ve worked with companies that ran product development through overseas contractors but failed to determine whether that created a taxable presence abroad. In diligence, buyers flagged potential income tax exposure in two jurisdictions and required indemnification provisions in the merger agreement. The value lost was not just financial. It was reputational.

Global expansion requires tax analysis—not just of where people work, but how money flows, who invoices whom, and whether transfer pricing policies exist. Even small international footprints should be reviewed for tax impact well before deal conversations begin.

Diligence-Ready Companies Win the Deal

The best acquirers don’t just buy companies. They buy confidence. A clean diligence process builds momentum. It signals that the leadership team has thought holistically about risk, has documented decisions, and has maintained institutional discipline.

Conversely, tax surprises—no matter how small—interrupt momentum. They cast doubt on the numbers. They expand the scope of legal review. They force last-minute trade-offs that hurt the seller far more than the buyer.

Founders often ask what they can do to maximize deal value. The answer is not always revenue growth or customer expansion. Sometimes, the greatest value comes from showing that the company is buttoned up, especially in areas like tax, where few expect early-stage companies to excel. That differentiation is subtle, but powerful.

Deal Risk Can Be Measured and Mitigated

Tax issues don’t have to derail transactions. They become deal-killers only when they surface too late. The key is to think like an acquirer—years before becoming one. That means modeling tax exposures, tracking deferred items accurately, reviewing state and international presence, and ensuring equity incentives are fully compliant and documented.

A deal-ready company is not perfect. It is simply prepared. And preparation begins with knowing that tax diligence is not a box to check. It is a narrative to shape.

Disclaimer: This blog is intended for informational purposes only and does not constitute legal, tax, or accounting advice. You should consult your own tax advisor or counsel for advice tailored to your specific situation.