Escrow is a common transactional term, and simply refers to money (or other assets) generally held by a third party instead of one of the parties directly involved in the transaction. Whether as collateral or simple proof that a company does in fact have the assets it says it does, escrow funds are held in a separate account. Consider it neutral territory.
In M&As, the end goal is to ultimately increase the value as a result of the completed transaction, and holding funds or assets in escrow is one way for a company to mitigate risk and ensure that the agreed-upon assets are indeed available for transfer. Should an agreement be altered or changed, keeping funds in escrow can be held until the terms are finalized, providing incentive for both parties to work together.
Escrow agreements can be used to retain a portion of the purchase price, sometimes called a “holdback,” during a specified warranty period that allows the buyer to verify any representations and warranties made by the seller. The holdback amount is automatically released if no warranty claims are made. Additionally, escrow funds provide security indicators that both parties in the agreement are able to meet the agreement’s covenants, potentially shortening the due diligence phase. Escrow agreements are also evidence of “good faith,” protecting the seller if the buyer has a change of mind on the deal.
Escrow can also prove valuable when it comes to earn-out payments. An “earn-out” is a contractual agreement in an M&A that provides additional future payments to the seller of a company contingent upon the company’s performance and worth after the sale. For example, if a buyer believes a business is worth less than the seller’s valuation, an earn-out provision can be used to provide future compensation to cover that difference over a set amount of time. An escrow account is a safe place to hold those funds and reassure the seller.
For international transactions, escrow accounts provide a secure repository for assets that may experience transfer delays due to deed or title registration issues, share certificate regulations, etc.
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Because of the multiple uses of an escrow agreement in M&As, it’s extremely important that buyers and sellers don’t leave them as an afterthought to the deal. Escrows can take time to properly structure and, when used intelligently, can help expedite an already lengthy process.
The attorneys at Hackstaff, Snow, Atkinson & Griess are well-versed in the complex matters of M&As, and can help structure escrow agreements that can help protect your interests. Contact us today to learn more.
