An escrow in M&A is a portion of the purchase price placed with a neutral third party (an escrow agent, usually a bank) and held for a defined period after closing. It exists to give the buyer a ready, funded source of recovery if the seller's representations or covenants turn out to be breached — rather than forcing the buyer to chase the seller for repayment after the proceeds have been distributed and spent.
How it works
At closing, instead of receiving 100% of the price, the seller receives most of it, and an agreed slice — commonly 5% to 15% of the purchase price — is wired to the escrow agent under an escrow agreement. If the buyer suffers a covered loss (a breached rep, an unpaid pre-closing tax, a working-capital shortfall), it makes a claim against the escrow. Undisputed amounts are paid to the buyer; the remainder is released to the seller when the escrow period ends.
Typical terms
- Size: ~5–15% of price, trending lower as R&W insurance has spread.
- Term: usually 12–24 months, aligned with the survival period of the seller's general representations (so the escrow is available for as long as claims can be brought).
- Special escrows: separate, sometimes larger or longer escrows for specific known risks — a pending lawsuit, an unresolved tax position, or environmental exposure.
- Working-capital escrow: a smaller, short-dated escrow dedicated to the post-closing working-capital true-up.
Why a third party holds it
Using a neutral agent — rather than the buyer simply withholding the funds (a holdback) — protects both sides: the seller knows the money is segregated and not at the buyer's discretion, and the buyer knows it is reserved and cannot be dissipated. Disputed claims are resolved per the escrow and purchase agreement mechanics (negotiation, then arbitration or litigation), with the agent paying out only on joint instruction or a final determination.
Escrow, holdback and R&W insurance
These three tools all answer the same question — how does the buyer get paid if the seller breached? — and are often combined:
| Who holds funds | Nature | |
|---|---|---|
| Escrow | Neutral agent | Seller's money, segregated |
| Holdback | The buyer | Buyer retains/defers payment |
| R&W insurance | Insurer | Third-party policy pays claims |
In larger deals, R&W insurance increasingly does most of the work, shrinking the escrow to a small amount covering only the policy retention and excluded items. In smaller deals, a traditional indemnification escrow remains the workhorse.
See also
- Holdback — Purchase-price consideration that the buyer retains rather than pays out at closing, to be released later subject to conditions. Function is similar to an escrow but with the buyer (not a third party) holding the funds.
- Indemnification — The contractual mechanism by which the seller compensates the buyer (or vice versa) for losses resulting from breaches of representations, warranties or covenants in the definitive agreement.
- Representations and warranties insurance — A policy that pays out for breaches of the seller's deal reps and warranties, replacing or supplementing the indemnification escrow. Now standard in most $20M+ private deals.
- Working-capital target — A negotiated benchmark — usually a trailing-12-month average — for the level of net working capital the seller is to deliver at closing. Variances above or below trigger a dollar-for-dollar price adjustment.
- Definitive purchase agreement — The binding contract that governs an acquisition and its terms.