A cap on liability is a contractual limit on monetary damages one party must pay if they breach representations, warranties, or other obligations.

How it works

In M&A and financing documents, sellers and founders often give representations and warranties about the business — cap table accuracy, IP ownership, no undisclosed litigation. If a rep proves false, the buyer may claim damages. Negotiations set a liability cap, commonly:

• A percentage of purchase price (e.g., a portion of enterprise value)
• The amount held in escrow for a survival period
• Insurance policy limits for D&O or reps and warranties coverage

Caps rarely cover fundamental breaches — fraud, willful misconduct, or failure to deliver stock — which may remain uncapped or subject to higher limits. Venture term sheets sometimes cap founder liability for minor disclosure issues separately from company obligations.

Insurance interacts with caps: reps and warranties insurance can raise effective recovery for buyers while lowering seller escrow holdbacks — but premiums and exclusions vary by deal size and sector risk.

Why it matters

• Founders: Understand what you are personally on the hook for in a sale or secondary. Caps protect against unlimited clawbacks but do not eliminate diligence obligations.
• Investors: As buyers of equity or companies, caps balance risk allocation. Too low a cap shifts diligence burden entirely to the buyer; too high a cap may kill founder-friendly deals.

Common mistake

Assuming a liability cap protects against all claims. Tax, employment, and environmental liabilities often survive outside standard caps unless explicitly included.

Related ideas

Representations and warranties, escrow, indemnification, D&O insurance, and change of control.