HOLDBACK / ESCROW - Business Purchase Agreement
Business Purchase - Letter of Intent - Due Diligence - Negotiations - Asset vs Share - Purchase Agreement - Closing
Contact Neufeld Legal PC at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
Holdbacks and Escrow arrangements are mechanisms used in business purchases to manage post-closing risks by setting aside a portion of the purchase price. These legal mechanisms are negotiated and written into the purchase agreement, with distinctive functions and results.
Holdback: A holdback is a portion of the total purchase price that the buyer withholds from the seller at the time of closing. The buyer retains control of the funds, with the holdback amount not being paid to the seller until certain post-closing conditions are met or a specified period of time has elapsed without an issue arising.
Escrow: Although escrow may appear similar to a holdback, an escrow arrangement sees a portion of the purchase price that is set aside being held by a neutral third-party agent (the "escrow agent," often a bank or law firm) at closing. The escrowed funds are placed into an escrow account controlled by the third party, based on a signed Escrow Agreement. Thereupon, the escrow agent will only release the funds to the buyer (for a claim) or the seller (after the period expires) based on joint written instructions from the buyer and seller, or according to the pre-agreed terms in the Escrow Agreement.
Holdbacks and escrows are critical risk mitigation tools that provide security and confidence for both parties, particularly the buyer.
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Protection Against Undisclosed Liabilities: The primary use is to cover indemnification claims—financial losses the buyer suffers if the seller breached their representations and warranties (promises about the business) in the purchase agreement. Examples include previously undisclosed tax liabilities, pending litigation, or inaccurate financial statements.
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Post-Closing Price Adjustments: They secure funds for final adjustments to the purchase price, most commonly related to working capital being different than agreed upon at closing.
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Seller Accountability: They motivate the seller to ensure all promises (like providing transition support, fulfilling a non-compete clause, or resolving a known issue) are met, knowing that failure to do so could result in a deduction from the held funds.
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Dispute Resolution: By having funds readily available in a holdback or escrow, the buyer can more easily recover losses without immediately resorting to a lawsuit against the seller. It thus acts as a pre-funded pool for claims.
From a preference standpoint, buyers typically prefer holdbacks, while sellers prefer escrow arrangements:
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Buyer Preference (Holdback): Buyers generally prefer a simple holdback because they retain control of the funds, providing them with more leverage and control over any potential claims.
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Seller Preference (Escrow): Sellers usually prefer an escrow because the funds are held by a neutral third party, ensuring the money is set aside and can't be unilaterally withheld by the buyer due to a spurious claim or the buyer's own financial distress.
A well-drafted business purchase agreement is the foundation of a successful acquisition. It should be a robust document that protects the buyer from future surprises and gives them clear remedies if the business is not as it was represented. For knowledgeable and experienced legal representation when purchasing a business, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
