Skeletons in the Closet: Unrecorded, Contingent, and Hidden Liabilities

Firms that choose to grow through a merger or acquisition can gain access to new markets, fresh ideas, new products or processes, and talented employees. However, the evaluation of any potential target company is a critical step that requires financial, operational, and legal expertise.

Financial due diligence helps the prospective buyer to evaluate the financial condition, legal status, and assets and liabilities of a target. This information is used in negotiating, structuring, and closing a proposed acquisition. In previous articles, we have examined normalization of earnings, cash considerations, and liabilities recorded on the balance sheet. Just as important as what is “on” the balance sheet is what is “off” – unrecorded, contingent, or otherwise hidden liabilities.

In order to uncover unrecorded, contingent, or hidden liabilities, it is important to make very specific requests of the target company. While circumstances are unique to each transaction, some issues to consider include:

  • Insurance: Obtain insurance loss runs directly from the insurance carriers and examine for open or unresolved claims.
  • Regulatory Issues: Determine which regulatory reporting entities have jurisdiction over the target. Review correspondence and regulatory reporting for the past 3-5 years. If necessary, independently review regulatory issues with industry experts.
  • Litigation: Request listing of professional expenses by invoice for the past 2 - 4 years. Select sample of invoices to review. Take note of any new legal counsel or spikes in professional expenses. This may uncover pending or threatened litigation and related contingent liabilities.

Off-balance-sheet liabilities are just one consideration in a comprehensive due diligence program that must be tailored to each individual target company. Schneider Downs has extensive experience in providing due diligence services. To learn more about how Schneider Downs can help you, please contact Joel Rosenthal at 412-697-5387.

© 2014 Schneider Downs. All rights-reserved. All content on this site is property of Schneider Downs unless otherwise noted and should not be used without written permission.

This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.

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