FA-301g · Module 2

Hidden Liability Identification

3 min read

The balance sheet shows declared liabilities. Due diligence uncovers undeclared ones. Pending litigation that has not been accrued. Tax positions that are aggressive and may be challenged. Employee obligations (vacation accruals, bonus commitments, severance upon change of control). Customer commitments (SLA credits owed, service obligations from over-sold contracts). Every hidden liability is a dollar the buyer inherits that was not in the price.

Due Diligence — Hidden Liability Scan:
──────────────────────────────────────────────────────
Category          Check For                  Risk
──────────────────────────────────────────────────────
Litigation        Pending claims, demand     $$
                  letters, regulatory
                  inquiries not accrued

Tax               Aggressive positions,       $
                  multi-state nexus,
                  uncollected sales tax

Employment        Change-of-control           $
                  bonuses, unvested equity
                  acceleration, accrued PTO

Customer          SLA credits owed,           $
                  contract disputes,
                  service scope creep

Vendor            Long-term commitments       $
                  above market, auto-renew
                  contracts with penalties

IP                Patent exposure, open-       $
                  source license violations,
                  ownership disputes
──────────────────────────────────────────────────────

Total hidden liability exposure in a typical
acquisition: 5-15% of purchase price.
Identify it or inherit it.

Do This

  • Request the full litigation log, including pre-litigation demand letters and regulatory inquiries
  • Review every employment contract for change-of-control provisions — especially the executive team
  • Audit vendor contracts for auto-renewal terms, price escalation clauses, and termination penalties

Avoid This

  • Rely on the seller's representation that "there are no material liabilities" — verify independently
  • Skip the tax review because "it is a small company" — small companies often have the most exposure
  • Assume customer contracts are standard — read the top 10 contracts for non-standard commitments