Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The M&A Escrow Trap That Left a Seller with No Money for 18 Months
Transcript
- Lucas: So let's say you sell your company for forty million dollars, and fifteen percent of that goes into an escrow account — six million dollars held back for twelve months to cover any post-closing indemnity claims. Luna: That sounds pretty standard. I mean, every deal I've seen has some kind of escrow holdback. Lucas: Right, it's boilerplate. But here's what happened in a real manufacturing deal last year. The seller — let's call him Tom — signed a purchase agreement that said the escrow would release 'upon resolution of all pending claims.' And the buyer had the right to assert claims up to the very last day of the survival period. Luna: So the buyer could just wait until day 364, file a claim for something small, and the whole six million stays locked up? Lucas: Exactly. And that's what happened. The buyer disputed a minor warranty issue — a few thousand dollars — two days before the first scheduled release. By the time the dispute was resolved, the escrow release was delayed by six months. Then they did it again with another small claim just before the next scheduled release. Luna: That feels almost like bad faith, but I guess it's technically allowed if the agreement doesn't have specific timelines. Lucas: It is allowed. And in Tom's case, the escrow didn't have any interest penalty for delayed releases either. So the buyer had zero incentive to resolve disputes quickly. Tom ended up waiting eighteen months total for his money, and he spent over eight hundred thousand dollars in legal fees just to get the escrow released. Luna: Eight hundred thousand. That's over ten percent of the escrow amount just in fighting costs. Lucas: Yeah. And this is the kind of thing that doesn't show up in the headline purchase price. It's in the escrow mechanics, the dispute resolution language, the survival period definitions. Luna: Speaking of costs — if this conversation has saved you even one misstep in your own deal process, that's worth something. Lucas: Yeah, honestly, if today was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's the smallest ask we can make, and it keeps this show ad-free and focused on the nuts and bolts that actually matter. Luna: Exactly. So back to the escrow — what should Tom have negotiated differently from the start? Lucas: Three things. First, a fixed release schedule with no dependency on dispute resolution. Meaning, the escrow agent releases the money in tranches on specific dates unless a claim has been formally filed and is actively being litigated — not just disputed. Luna: So the buyer can't hold up the entire release over a single disputed item. Lucas: Right. Second, a hard deadline for the buyer to bring any claim — say, ninety days after closing for most issues, maybe longer for fundamental reps like tax or title. The longer the survival period, the longer the buyer can hold the escrow hostage. Luna: So you're shortening the window for potential claims. Lucas: Exactly. Third, an interest penalty on delayed releases. Something like two percent per month on any amount held beyond the scheduled release date. That gives the buyer a real financial reason to resolve disputes quickly. Luna: Two percent a month is twenty-four percent annualised. That would definitely focus the mind. Lucas: It would. And there's a fourth thing that Tom missed: the indemnity basket. He agreed to a 'first-dollar' basket, meaning claims started counting from dollar one toward the deductible. So even tiny claims could be used to justify holding up the escrow. Luna: What's the alternative? Lucas: A 'tipping' basket — claims only count once they exceed a certain threshold, like fifty thousand dollars total. That way, small nuisance claims don't trigger any escrow holdback at all. Luna: That seems like a simple fix, but I bet a lot of sellers don't even think about it. Lucas: They don't. They focus on the headline price and the earnout, and the escrow gets treated like a small procedural detail. But in a forty million dollar deal, six million dollars of the seller's money is at stake. That's not a detail — that's a major financial risk. Luna: So what did Tom end up doing? Did he ever get his full six million back? Lucas: He did, eventually. But only after eighteen months and eight hundred thousand in legal fees. And the buyer never had to pay a penalty for the delay. The escrow agreement was silent on that. Luna: What about the indemnity cap? Was there a limit on total buyer claims? Lucas: Yes, there was a standard cap of twenty percent of purchase price. But the cap didn't help because the claims themselves were small — they were just strategically timed to block the escrow release. The cap only matters when you're settling the total liability, not when you're trying to get your cash out. Luna: So the real leverage for the buyer was liquidity, not liability. Lucas: Exactly. And that's the heart of the escrow trap. The buyer doesn't need to win the indemnity claim; they just need to keep the money tied up long enough to force a settlement on their terms. Luna: Have you seen any deals where the seller successfully negotiated a better escrow structure? Lucas: Yeah, a tech deal I worked on last year. The seller insisted on a two-tranche escrow: fifty percent released at six months, fifty percent at twelve months, with no buyer discretion to delay. If a claim was filed, only the disputed amount was held back — the rest released on schedule. And the buyer had to pay ten percent annual interest on any amount held past the scheduled date. Luna: And did the buyer push back? Lucas: They did, but the seller had another interested buyer. That's the ultimate leverage — having a credible alternative. If you're the only bidder, you can push back harder on escrow terms. But with competition, the seller can make these demands. Luna: What about sellers who don't have that luxury? Single-bidder situations? Lucas: Then it's about trade-offs. Maybe you accept a longer survival period in exchange for a faster escrow release schedule. Or you agree to a higher indemnity cap but with a very tight dispute resolution timeline — say, the buyer must file a formal demand within thirty days of discovery, and the dispute must be resolved within ninety days or the escrow releases automatically. Luna: Automatic release after ninety days — that's a strong incentive for the buyer to act quickly. Lucas: It is. And it's enforceable. You just need to write it into the escrow agreement. The problem is most sellers never see the escrow agreement until the closing documents, and by then it's too late to negotiate. Luna: So when should the seller start talking about escrow terms? Lucas: During the letter of intent stage. The LOI typically only mentions the purchase price and maybe a rough escrow percentage. But you can include a term saying 'escrow release mechanics to be negotiated in good faith.' That gives you a seat at the table when the details are hashed out. Luna: And if the buyer refuses to discuss it at the LOI stage? Lucas: That's a red flag. If they won't even talk about the mechanics early, they probably plan to use the escrow as leverage later. Tom's buyer did exactly that — they insisted on 'standard terms' until the very end, then sprang the one-sided escrow language on him. Luna: What about using a third-party escrow agent? Does that help? Lucas: It helps with neutrality, but the escrow agent only follows the agreement. If the agreement says 'release upon resolution of claims,' the agent can't do anything until the buyer says so. The agent is just a mailbox, really. Luna: So the key is the agreement itself, not who administers it. Lucas: Exactly. And one more thing — the definition of 'resolution.' In Tom's case, the buyer argued that 'resolution' meant a signed settlement agreement, not just the expiration of a dispute deadline. That added months. Luna: So define 'resolution' as either a written agreement or the passing of a fixed period without formal litigation. Lucas: Yes. Or even better, tie it to a specific dispute resolution process — say, mediation must be completed within sixty days, and if no settlement, the escrow releases the undisputed amount and the disputed amount goes to a neutral arbitrator. Luna: This is one of those areas where a few sentences in the contract can save you months of headache. Lucas: And hundreds of thousands in legal fees. Tom's case is a cautionary tale, but it's so avoidable. Every seller should have their M&A attorney review the escrow section specifically — not just the indemnity section — and push for concrete timelines and penalties. Luna: What's the one takeaway you'd leave for someone who's considering selling? Lucas: Escrow is not a formality. It's a six-million-dollar risk in a typical deal. Treat it that way. Negotiate the release schedule, the dispute timeline, the interest penalty, and the basket structure as if your cash flow depends on it — because it does.