How does the buyer typically protect themselves against hidden liabilities in a deal?

The correct approach for a buyer to protect themselves against hidden liabilities in a deal is through the use of an escrow account. In M&A transactions, an escrow account serves as a financial safeguard where a portion of the purchase price is held by a neutral third party for a specified period following the closing of the deal. This mechanism allows the buyer to have recourse to these funds in case any unforeseen liabilities arise after the transaction is completed.

The escrow amount can be used to cover any claims related to undisclosed liabilities, such as litigation or environmental issues that were not revealed during the due diligence phase. By having this financial buffer, the buyer ensures that potential risks are mitigated, and they have a means to recover losses without directly impacting their cash flow or financial stability.

Other methods mentioned, like thorough background checks, are useful for identifying potential red flags before a deal is closed, but they don't provide the same level of financial assurance against hidden liabilities post-closing as an escrow account does. Similarly, relying on cash reserves can be beneficial for handling unexpected costs but does not structure the protection as effectively as having funds specifically set aside for this purpose. Lastly, performance bonds are generally used to guarantee the completion of a project or service and do not directly address the issue