Valuation of Contingent Liabilities for M&A Transactions and Bank Borrowing

Contingent liabilities - particularly those tied to litigation, regulatory exposure, or environmental matters - are among the most consistently underestimated threats in corporate finance. When misjudged or ignored, these risks can materially distort a company’s financial reality and compromise long-term strategy. Consequences include heightened insolvency risk, failed M&A transactions, distorted financial projections, reputational harm, and even malpractice exposure for advisors who overlook them.

As valuation professionals, we frequently face situations where uncertainty becomes a core input into enterprise value. The firms that succeed are those disciplined enough to quantify that uncertainty. Yet traditional valuation approaches often isolate contingent liabilities as a footnote rather than analysing their systemic ripple effects across cash flow, solvency, and deal strategy.

How Contingent Liabilities Impact Business Value

Contingent liabilities rarely stay confined to the legal department. They reverberate across financial statements and strategic planning. Their impacts typically fall into four key categories:

1. Cash Flow Erosion

Ongoing litigation expenses (legal fees, discovery, expert witnesses, settlement reserves) directly reduce free cash flow. For companies with thin margins, this quickly erodes the ability to reinvest, fund capital expenditures, pursue accretive M&A, or satisfy lender covenants. In severe cases, companies must prioritise legal survival over operational growth.

2. Constraints on Access to Capital

Prospective lenders and investors treat material contingent liabilities as structural risk factors. Their response often includes higher interest rates, lower advance rates, increased collateral requirements, or delayed/withdrawn commitments. Similarly, in M&A processes, buyers heavily discount valuations when uncertainty clouds forward cash flows.

3. Reputational Damage

Reputational fallout can compound financial strain. Companies may face customer attrition, cancelled vendor relationships, increased competitive pressure, declining employee morale, and hesitation from strategic or financial buyers. In industry-wide litigation events, this reputational drag can affect not only the company but perceptions of the sector as a whole.

4. Depressed Enterprise Value

Contingent liabilities influence nearly every major variable in a valuation model - from revenue growth and margins to working capital needs, discount rates, and terminal value assumptions. Without a defensible, data-driven approach, enterprise value becomes untethered from economic reality.

Case Study: Transforming Uncertainty into Leverage

Manufacturing & Distribution Company

Context:A long-established manufacturer and distributor had been named in more than 500 industry-wide toxic tort lawsuits. The exposure threatened solvency and jeopardized a planned near-term sale.

Issue:The volume and nature of the claims created a scenario in which adverse verdicts could threaten solvency, legal fees were escalating each quarter, potential buyers were withdrawing due to uncertainty, and the company’s valuation was being discounted before diligence even began. Without intervention, both daily operations and the pending sale were at risk.

SP&H Solution

SP&H valued the contingent liabilities using a rigorous, methodical framework grounded in precedent and statistical analysis.

1. Exhaustive Historical Research

We conducted deep research into historical cases, industry-specific verdicts and settlements, plaintiff characteristics, jurisdictional tendencies, and exposure patterns.

2. Probability-Weighted Statistical Modeling

Each lawsuit was evaluated using probability distributions tied to historical outcomes, adjusted for industry shifts and emerging legal trends.

3. Collaboration with Legal Experts

We engaged extensively with the company’s internal counsel and external legal specialists to validate assumptions, confirm procedural timelines, and refine risk assessments.

4. Sensitivity & Solvency Analysis

We ran best-, worst-, and most-likely-case solvency scenarios incorporating cash flow stress tests, liquidity assessments, and balance sheet impact modelling.

Results

The analysis reshaped the company’s strategic direction by delivering several critical insights:

• Even in a worst-case scenario, the company remained solvent—providing the Board and management confidence to continue the sale process.

• Probability-weighted cash flow modelling demonstrated adequate capacity for operations and debt service, reducing lender and investor concerns.

• The balance sheet remained fundamentally sound, as litigation costs and verdict exposure were quantifiable and manageable.

• The rigorous analysis bolstered the company’s reputation by demonstrating transparency and responsible financial governance.

• Employee morale improved as management communicated a clear, credible roadmap through uncertainty.

Disciplined valuation methodology transformed a serious threat into strategic leverage—improving buyer negotiations, strengthening lender relationships, and restoring organizational confidence.

Conclusion

SP&H’s approach, grounded in statistical rigor, legal collaboration, and scenario-based modelling, equips companies, investors, lenders, and boards with clarity during moments of uncertainty. Organizations that adopt this framework build credibility over time, becoming known not only for valuation accuracy but for navigating risk with strategic discipline.

For companies facing litigation, regulatory exposure, or industry-wide legal events, a disciplined contingent-liability valuation can preserve enterprise value, support strategic transactions, and reinforce trust with stakeholders.

If your organization is confronting material contingent liabilities, SP&H can help you quantify the risk and chart a strategic path forward.