Definition
Escrow is an arrangement in which an independent third party, such as a bank, an escrow agent or a law firm, holds money or documents until agreed conditions are met. In business sales, part of the purchase price is often placed in escrow for a set period after completion to cover warranty claims, price adjustments or an earn-out. Neither buyer nor seller can release the money alone.
An earn-out is part of the purchase price paid only if the business meets agreed targets after the sale. It can bridge a gap between the seller's price and the buyer's view of the evidence.
Worked example
A fictional buyer purchases Bluegum Solar Installations Pty Ltd, a fictional Australian business, for A$2,000,000. The agreement says:
- A$1,800,000 is paid to the sellers at completion
- A$200,000 goes into an escrow account held by a law firm for 18 months
- the law firm releases money only on joint instructions from both sides or a final decision on a dispute
Ten months later, a customer claim for faulty installation work costs A$30,000, which the warranties cover. Both sides sign joint instructions, A$30,000 goes to the buyer and the remaining A$170,000 is released to the sellers at the end of the 18 months.
Warranties are the seller's statements of fact about a business in the purchase agreement; indemnities are promises to reimburse specific losses. Together they decide who bears risks that diligence could not rule out.
Why buyers care
A warranty or indemnity is only as useful as your ability to collect on it. Once a seller has spent or moved the sale proceeds, recovering money can be slow and expensive. Escrow keeps a pool of money available and out of either side's control.
Agree the amount, the period, the release conditions and who pays the escrow fees. Match the period to the risks you found in diligence, such as the time a tax authority has to reopen past returns. A holdback, where you keep the money yourself, gives you more control but is less comfortable for the seller. Weigh the options with your lawyer.
Due diligence is the investigation a buyer carries out before committing to a purchase, testing the finances, contracts, legal position and operations against what the seller has described.
A holdback is part of the purchase price the buyer keeps back at completion and pays later if no valid claims arise. Unlike escrow, the money stays with the buyer.