A mechanism whereby part of the purchase price is deposited in an account controlled by an independent third party, serving as security against potential contingencies or seller breaches after closing.
In a business acquisition, the seller wants to collect 100% of the price at closing and the buyer wants protection against surprises that surface afterwards. The escrow is the middle ground: a portion of the price is set aside in an independent account until it is confirmed that there are no hidden contingencies.
An escrow is a contractual and financial mechanism whereby part of the purchase price is deposited in a bank account controlled by an independent third party — typically a bank, a notary, or a professional escrow agent — for a defined period after closing.
The deposited funds serve as security against potential buyer claims arising from:
If no claims materialise during the retention period, the funds are released in full to the seller. If contingencies arise, the buyer can request payment from the escrow account following the procedure established in the contract.
A typical M&A escrow agreement defines:
For the buyer, the escrow is the most direct and effective protection tool. Unlike a contractual indemnity (which requires suing the seller and enforcing a judgment), the escrow makes funds immediately available. If the seller has disappeared, changed jurisdiction, or simply lacks liquidity, a contractual claim may be ineffective. With an escrow, the money is already there.
For the seller, the escrow represents an opportunity cost. The retained funds are unavailable for reinvestment or distribution. There is also the risk that the buyer files unfounded claims to keep the escrow locked as long as possible. That is why the seller must negotiate clear release mechanisms and short response timelines.
| Mechanism | Advantage | Disadvantage |
|---|---|---|
| Escrow | Funds immediately available | Seller loses liquidity |
| Price holdback | Similar to escrow but no agent | Less security for the seller |
| W&I insurance | Frees the seller | Premium cost, exclusions |
A logistics company in southern Spain is sold for 18 million euros. The due diligence identifies a potential tax contingency of 600,000 euros (an aggressive depreciation deduction approach over the past three fiscal years) and an open employment dispute valued at 200,000 euros.
The parties agree:
At 18 months, with no general claims, the 1.8 million is released to the seller. The tax escrow is released at 42 months when the limitation period expires without tax authority action. The employment escrow is released when the court dismisses the claim.
In the mid-market, the standard is 10% to 20% of the purchase price. The percentage depends on the risk level identified during due diligence and each party’s negotiating leverage. In transactions with specific identified risks, additional escrows may be established above the general percentage.
The standard period is 12 to 24 months. For specific contingencies (tax risks with long limitation periods, open litigation, environmental warranties), part of the escrow may extend to 36 or 48 months.
Yes, and it is increasingly common in the mid-market. A W&I insurance policy can cover the same risk, freeing the seller from the price holdback. However, escrow may still be necessary for specific identified contingencies (known risks) that W&I policies typically exclude.
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