Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / How the SPA Indemnity Holdback Traps Sellers in M&A
Transcript
- Lucas: You've negotiated your letter of intent, you've agreed on a valuation, the lawyers are finishing the definitive agreement, and then you see it — Article 6, the indemnification section — and buried in there is a reference to a holdback. It's going to say something like '15% of the purchase price shall be deposited into an escrow account to secure the seller's indemnification obligations.' And if you're a first-time seller, you probably think, well, that's standard. It's not a problem. Luna: But it is a problem. I've seen founders treat it as a minor detail, and it ends up costing them millions. Lucas: Exactly. That holdback is effectively a post-closing hostage situation. Let's use a real example. I worked with a founder who sold his industrial distribution company for $50 million. The buyer — a larger strategic — insisted on a 15% holdback, $7.5 million, sitting in escrow for 18 months. The purchase agreement had standard language: the holdback would be released 18 months after closing, subject to any pending indemnity claims. And the buyer filed a claim literally on day one. Luna: Wait — day one? What was the claim? Lucas: A working capital adjustment dispute. The buyer argued that the company's accounts receivable at closing were overstated by $800,000. That triggered a dispute resolution process that dragged on for six months. Meanwhile, the buyer kept finding other issues — a customer contract that had a change-in-control clause they said wasn't disclosed, a minor environmental permit that was technically expired. By month 12, the buyer had asserted $2.1 million in total indemnity claims. Luna: And the seller is just watching their escrow dwindle. Lucas: Worse — they're paying lawyers to fight each claim. That founder spent $400,000 in legal fees just to negotiate the release of the remaining escrow. At the end, he got back about $4.8 million of the original $7.5 million, less than 10% of his sale proceeds. And the holdback itself didn't earn any interest — the escrow was held in a non-interest-bearing account. Luna: So the buyer essentially got a $2.7 million discount on the purchase price, plus free financing for the holdback period. Lucas: That's exactly how buyers see it. The indemnity holdback is a post-close leverage tool. And it's particularly dangerous in middle-market deals where the seller doesn't have the same legal firepower. The standard form from the buyer's law firm will always have a 10% to 20% holdback, a 12- to 24-month survival period, and a broad basket — meaning the buyer can claim for any loss over a small threshold, often as low as $50,000. Luna: So what should a seller push back on? I assume the first thing is the percentage. Lucas: Absolutely. But it's not just the percentage — it's the structure. The smartest sellers I've seen negotiate what's called a 'survival-only escrow' or a 'decreasing cap.' The key is to cap the holdback at the lowest possible percentage, ideally 5% or less, and to tie its release to a schedule. For example, half the holdback released at month 6, the remainder at month 12, with no ability for the buyer to re-assert claims on amounts already released. Luna: That sounds like a 'staged release' — I've seen those in larger deals but not as often in the lower middle market. Lucas: Right, but they're worth fighting for. The other critical term is the 'exclusive remedy' clause. You want the SPA to say that the escrow holdback is the buyer's sole and exclusive remedy for all post-closing claims. That prevents the buyer from suing you separately for fraud or breach of representation on top of the escrow. Without that, the holdback is just the starting point. Luna: And I'd add one more: the materiality scrape. That's the provision that says when you're determining whether a loss exceeds the basket threshold, you disregard any qualifiers like 'material' or 'material adverse effect' from the representations. If the SPA says the seller represented that all contracts were 'in material compliance,' the buyer can't use a tiny, immaterial non-compliance to trigger an indemnity claim. Lucas: That's a great point. In the industrial distributor case, the buyer claimed a change-in-control clause was a breach, but the contract had a $10,000 annual value — it was trivial. Without a materiality scrape, the buyer could still assert it and force the seller to spend legal fees defending it. A materiality scrape would have killed that claim at the outset. Luna: So if a founder is preparing to sell, what's the one thing you'd tell them to focus on in the indemnity section? Lucas: I'd say: don't let the buyer set the holdback percentage and survival period as a take it or leave it term. Push for a cap of 5% to 10%, a survival period of no more than 12 months, and a staged release. And insist on exclusive remedy and a materiality scrape. If the buyer resists, ask them why they need 18 months to find problems — if they've done proper due diligence, they should know what they're buying. Luna: That's a strong framing. And frankly, if the buyer is unwilling to compromise on those points, it tells you something about how they'll behave post-close. Lucas: It's a red flag. I've seen deals fall apart over this exact issue, and honestly, sometimes that's the best outcome for the seller. But the key is to go in knowing that the holdback is not a neutral escrow — it's a bargaining chip. Luna: Speaking of bargaining chips — you know, conversations like this are exactly why we do this show. If you've gotten value from our deep dives on deal terms, and you want to help keep this podcast ad-free and independent, you can support us at buy me a coffee dot com slash fexingo. It's a small way to make sure we can keep digging into the nitty-gritty of M&A for operators. Lucas: Yeah, we don't run ads, so listener support is what makes this possible. And it genuinely helps us invest more time into episodes like this one. So if that's something you can do, we appreciate it. Luna: Alright, back to the indemnity holdback. One more nuance I want to mention: the difference between an escrow holdback and a simple holdback where the buyer just withholds part of the purchase price and releases it later. The escrow structure at least gives you a neutral third party holding the money. In a simple holdback, the buyer holds your money directly. That's far riskier. Lucas: That's a critical distinction. In a simple holdback, the seller is essentially extending credit to the buyer — unsecured. If the buyer goes bankrupt or simply refuses to release funds, you're in line with other creditors. Always insist on a third-party escrow, preferably with a reputable bank or title company. And get the escrow agreement signed at closing, not after. Luna: And the interest? Most escrow accounts can be interest-bearing. You want that interest to accrue to the seller, not the buyer, unless there's a claim. That's another thing founders overlook. Lucas: It's surprising how many sellers don't even ask. On a $7.5 million holdback over 18 months at, say, 2% interest, that's $225,000 in lost income. It's not insignificant. But the bigger issue is the claims process. Even with a perfect SPA, if the buyer is aggressive, you're going to spend legal fees. So the best defence is a clean deal with strong protections from the start. Luna: Let's talk about the survival period. Is 12 months standard? I've seen 18 and even 24 months in some deals. Lucas: In the middle market, 12 months is the norm for general representations. But buyers will push for 18 to 24 months for fundamental representations — those are the ones about title, authority, capitalization, tax matters. Those tend to survive longer, sometimes up to the statute of limitations. That's reasonable. The key is to limit the survival of the non-fundamental reps to the shortest possible period. And make sure the survival period starts at closing, not at signing. Luna: And the basket? That's the threshold below which the buyer can't bring a claim. You want it high enough to discourage nuisance claims. Lucas: Exactly. A typical basket is 0.5% to 1% of the purchase price. On a $50 million deal, that's $250,000 to $500,000. And you want it to be a 'deductible' basket, not a 'first-dollar' basket. A deductible basket means the buyer bears the first losses up to the basket amount; a first-dollar basket means once the buyer exceeds the basket, they can claim the entire amount, including losses below the basket. That's a big difference. Luna: I've seen sellers accidentally agree to a first-dollar basket because they didn't read the definition carefully. It can cost them hundreds of thousands. Lucas: It's one of those details that separates a well-advised seller from one who just signs the buyer's form. And that's really the takeaway here: the indemnity holdback section is not boilerplate. It's a negotiation. If you're a founder or operator preparing to sell, spend the time to understand each term. Hire a good M&A attorney who has done seller-side work. It will pay for itself many times over. Luna: And if you're a buyer listening? The holdback is insurance. But pushing too hard can kill the deal or poison the relationship. Fair terms benefit both sides. Lucas: Well said. Next time, we'll look at another deal term that often trips up sellers: the non-compete agreement and how far courts will enforce it in 2026. Until then, keep negotiating.