Investing in a startup can feel thrilling. You meet a passionate founder, hear a bold vision, maybe see a shiny prototype. It’s easy to imagine you’re looking at the next breakout success. But there’s a reason seasoned investors carry a bit of caution with them. Beneath all the excitement, startups sometimes carry hidden liabilities. Things that don’t show up on the pitch deck or the first conversation.

I’ll admit, the first time I looked into backing a startup, I was so focused on the product that I didn’t dig deep enough into the less glamorous details. Later, I learned there had been a messy dispute over ownership of the code. Nothing had exploded yet, but it could have, and that realization made me rethink how I approached due diligence.

So why does this matter? Because startups are already fragile. Some estimates put the failure rate at around 90% over time (Exploding Topics, 2024). The reasons vary, but common themes include financial mismanagement, legal disputes, team breakdowns, and market misalignment. According to CB Insights, 42% of failed startups admitted they built something with no real market need. Others failed due to funding gaps or founder disputes (CB Insights, 2024). These are not just bad luck. Many of them are liabilities that could have been spotted earlier if investors had looked closely.

Let’s walk through the main areas where these hidden liabilities tend to hide. I’ll bring in a mix of data, some observations, and the kind of questions I think are worth asking before putting money on the table.

Financial Weak Spots

Start with the money. If something feels off in a startup, there’s often a trail in the financials. Early-stage companies don’t need to be profitable yet, that’s normal. But they do need transparency.

Hidden liabilities can be tax bills, outstanding loans, unpaid obligations to contractors, or even side agreements the founder hasn’t put into the official books. Attorney Aaron Hall notes that hidden liabilities can include things like pending litigation costs, tax liabilities, or debts that significantly impact a company’s financial health (Hall, 2023).

When reviewing financials, I’ve learned to look for inconsistencies. For example, are revenues showing up in one place but not supported by bank deposits? Are there sudden unexplained spikes? If something looks too good to be true, it might be. Once I saw a startup counting a one-time grant as recurring revenue. Technically not illegal, but very misleading.

Cash flow is another subtle red flag. Running out of money is a leading reason startups fail (Skynova, 2022). If burn rate is high and the next funding round is assumed but not secured, that’s essentially a hidden liability in disguise. The company may be one slow quarter away from collapse.

Legal Landmines

The legal side isn’t glamorous, but it’s where some of the biggest dangers hide. Lawsuits, intellectual property disputes and regulatory problems all can quietly sit in the background until they suddenly dominate.

Papermark’s research notes that thorough legal due diligence helps uncover hidden liabilities or compliance issues that could seriously impact the company’s future (Papermark, 2024). That includes ownership of intellectual property. If the code was written by a contractor, did they sign over rights? If a founder left a previous employer recently, is there a chance that employer could claim ownership of the new product? These are real possibilities.

Pending lawsuits are another. Sometimes founders won’t bring them up unless asked directly. Even a cease-and-desist letter can be a big deal. And corporate structure matters too. If the cap table is messy say, early investors or ex-partners still hold unusual rights that can complicate future fundraising.

Regulatory compliance is equally important in industries like fintech or healthtech. I once looked at a fintech startup operating without the licenses they needed. That’s not just risky, it’s practically an invitation for regulators to shut them down. Non-compliance is an invisible liability until the day fines arrive.

Market and Business Model Risks

Not every liability shows up in contracts or financials. Some are structural. The most dangerous is misjudging the market. Again, 42% of failures happen because there was no market need (CB Insights via Maven, 2024).

A founder’s pitch will almost always include a massive Total Addressable Market figure. That’s fine, but investors should verify. Is there proof of demand right now? Letters of intent, paying customers, repeat usage those matter more than projections.

Another subtle liability is customer concentration. If most revenue comes from a single client or partner, losing that relationship could cripple the startup. It doesn’t always show up as a warning sign on first glance. But digging into revenue sources can reveal this dependency.

Competition is another quiet risk. Sometimes founders insist they have no competitors, but in reality, the competition is an Excel sheet or an entrenched habit. Assuming customers will switch is not the same as proving they will. And if a giant like Google or Microsoft could build a similar product overnight, that should factor into your risk assessment.

The People Factor

It’s often said that investors bet on people as much as ideas. That sounds like a cliché, but the numbers back it up. The Founders Forum reports that 23% of startups fail because of team problems lack of the right skills, or internal conflict (Founders Forum, 2024).

Founder disputes are especially common and can derail everything. A polished pitch may hide tension, but it’s worth asking how they handle disagreements. If the answer is that they’ve “never really had any,” that might actually be a red flag. Disagreements are natural. What matters is how they resolve them.

Team competence matters too. If it’s an AI startup without any actual AI expertise on the team, that’s a liability. If it’s a healthtech company with no one who understands healthcare regulations, same problem. It doesn’t always appear on a balance sheet, but it will surface eventually.

Culture is harder to measure, but still worth considering. High employee turnover, a domineering founder, or a toxic work environment may not show up in documents, but they affect execution. And execution is what turns ideas into companies.

Operational Due Diligence

This is the less flashy side of investing, but one of the most revealing. Operational due diligence asks: how does the startup actually run?

A business might look fine externally while being held together internally by manual processes or a single person’s memory. That’s risky. For instance, if only one engineer knows how to deploy the product and nothing is documented, that’s a hidden liability.

Operational dependencies are worth mapping too. If a company relies entirely on one supplier, or if their product depends on access to an external API that could change terms, that’s fragile. These are the kinds of things Papermark highlights when discussing operational risk: dependencies, scalability issues, and lack of internal controls (Papermark, 2024).

Technical debt is another invisible liability. Startups sometimes build quickly to launch, but the result is messy code that won’t scale. It works for 100 users but not 10,000. Unless someone looks closely — ideally a technical advisor — this may stay hidden until growth exposes it.

Wrapping It All Together

What does all this mean for investors? It means that spotting hidden liabilities is less about paranoia and more about realism. Every startup will have risks. The goal isn’t to find a perfect company, because that doesn’t exist. It’s to uncover the risks early, decide whether they’re manageable, and price or structure your investment accordingly.

Some liabilities can be mitigated. For example, if there’s a pending lawsuit, you might negotiate protections or wait until it’s resolved. If burn rate is too high, you might push for a plan to reduce expenses. The point of due diligence is not to kill every deal. It’s to enter deals with your eyes open.

And perhaps most importantly, transparency itself is a signal. If a founder acknowledges weaknesses openly, it builds trust. If they insist everything is perfect, that’s when I get cautious. Because in startups, nothing is perfect.

So, to any investor considering an early or growth-stage startup: take the time to dig into financials, legal issues, the team, operations, and the market. Ask the obvious questions. Ask the awkward ones too. The hidden liabilities you find may not always be deal-breakers, but the ones you miss often are.