Escrow: The Cash You Don’t Actually Get at Closing
Escrow is the portion of the sale price held back at closing by a third party, used to secure post-closing indemnification claims and working capital adjustments. Standard in every deal; the structure determines how much of ‘your’ money you can actually access when.
What is an M&A Escrow?
Escrow in M&A refers to funds held by a third party (the escrow agent — typically a bank or specialized escrow service) at closing, available to secure post-closing obligations of the seller. Most commonly: indemnification for rep and warranty breaches, and working capital adjustments.
Mechanically: at closing, the buyer wires the full purchase price — but rather than 100% going to the seller, a portion is wired to the escrow agent. The seller has a claim on those funds, but cannot access them until the escrow period ends and any unresolved claims have been settled.
Escrow is one of the most universal features of M&A transactions. The exact structure (amount, holding period, release mechanics) is heavily negotiated and significantly affects how much cash the seller actually controls post-closing.
Typical Escrow Structures
Indemnification escrow
The primary escrow in most deals. Holds funds to secure rep and warranty indemnification claims.
- Without RWI: Typically 5%–15% of deal value. Held for 12–24 months (matching the general rep survival period).
- With RWI: Typically 0.5%–1% of deal value (mainly to cover the policy retention and fundamental reps).
Working capital escrow
Often a separate, smaller escrow specifically to cover the post-closing working capital true-up. Typically 0.5%–2% of deal value; released 30–90 days post-closing after the true-up is finalized.
Specific indemnity escrow
Sometimes a separate escrow for known issues (pending litigation, environmental matters, tax disputes). Sized to cover the estimated exposure; held until the underlying matter is resolved.
Earnout escrow
In deals with earnouts, sometimes the contingent payments are placed in escrow rather than relying on the buyer’s continued solvency. Less common but provides seller protection.
How Funds Get Released
The escrow agreement specifies exactly how funds are released. Typical mechanics:
- Joint instructions. Both buyer and seller sign release instructions to the escrow agent.
- Scheduled release dates. Funds release automatically on specified dates (e.g., 50% at 12 months, balance at 24 months) unless a claim is pending.
- Pending claims hold. If a buyer has filed an unresolved claim, the disputed portion stays in escrow until resolved — even if the scheduled release date has passed.
- Final release. At the end of the survival period, all remaining funds release to the seller (after deduction for any settled claims).
Interest on escrowed funds typically accrues to the seller (since it’s the seller’s money). Make sure this is specified in the escrow agreement.
Key Negotiation Points
Escrow size
Smaller escrow = more cash at close for seller. Push for 5% (or smaller with RWI) rather than 10–15%.
Holding period
Shorter holding period = faster access to funds. Push for 12 months rather than 24 wherever possible.
Tiered release
Tiered releases (e.g., 50% at 12 months, balance at 24 months) are better than all-at-end releases. Even better: smaller escrow with no tiered releases.
Escrow as exclusive remedy
The cleanest seller position: escrow is the only source of indemnification recovery. Once the escrow is depleted (or released), the seller has no further indemnification exposure. Hard to achieve but worth pushing for.
Escrow agent fees
Typically paid by buyer or split. Make sure the agreement specifies who pays.
Pending claim threshold
How much of the escrow is held pending claims? Some agreements hold the entire escrow if any claim is pending; better practice is to hold only the disputed amount.
Worked Example
At closing: Buyer wires $20M total. Seller receives $18M in cash; $2M goes to indemnification escrow.
Working capital adjustment is finalized 60 days post-close: $150K owed to buyer. Released from a separate $400K working capital escrow.
At 12 months post-close: $1M of the indemnification escrow releases to seller (50% tier).
Buyer files $300K claim 15 months post-close. The disputed $300K stays in escrow; the remainder ($700K minus $300K = $400K) releases to seller per the scheduled release.
Claim resolves 6 months later: buyer entitled to $150K. $150K paid to buyer; $150K released to seller. Final remaining $400K from working capital escrow also returns.
Seller total recovery: $18M at close + $1M + $400K + $150K + $400K = $19.95M out of the original $20M deal value.
Other Terms You’ll Encounter Around This One
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About This Guide
This guide is for general educational purposes. Escrow structures are highly deal-specific. We are not attorneys; consult a qualified M&A attorney for any specific escrow negotiation.