Latest / The Acquisition Talk with Fexingo: Mergers, Buyouts, and Business Sales for Operators / The Escrow Trap That Cost a Seller 19 Million
Transcript
- Lucas: So there's a classic line in every M&A deal: 'we'll put ten percent in escrow for eighteen months, standard.' And most sellers shrug and agree. But the escrow agreement — that one-page document nobody reads — just cost a seller nineteen million dollars. Luna: Nineteen million? That's not a rounding error. What happened? Lucas: This was a niche industrial services company, about two hundred million in revenue, sold to a private equity-backed competitor. The purchase price was a hundred and ninety million. They agreed to a ten percent escrow — nineteen million — to cover post-closing indemnity claims, standard. Luna: So the nineteen million is sitting in a bank account. How do you lose it? Lucas: The way you lose it is the escrow agreement had two clauses that turned a routine holdback into a five-year hostage situation. First, the release was tied to the resolution of all outstanding claims — not just the ones pending, but any claim that could be asserted. Second, the dispute resolution clause required arbitration, but it didn't specify a timeline, and it gave the buyer the right to extend the escrow period unilaterally if they filed a notice. Luna: So the buyer could just file a claim and park the money indefinitely. Lucas: Exactly. The buyer filed a claim for a minor environmental issue — a small leak at a facility that the seller had disclosed in the data room. But the claim was worded to include 'any related or successor claims,' and the arbitration dragged on for thirty months. Meanwhile, the escrow money sat in a custodial account earning next to nothing. Luna: But eventually the claim resolved, right? The seller must have gotten most of it back. Lucas: The claim resolved, but the escrow agreement had a release mechanism that required the buyer's counsel to sign off on the release — and their counsel refused to sign until the seller waived any claims against the buyer for bad faith. The seller's attorneys said that was overreach, so they refused. And here's the kicker: the escrow agreement didn't have a deadline for the release. So the money just stayed frozen. Luna: So the seller never got the nineteen million? Even after winning the arbitration? Lucas: They won the arbitration. The arbitrator found the buyer's claim was baseless and ordered the release. But the escrow agent — because the agreement didn't specify that the arbitrator's award was final and binding on the release — the escrow agent said they needed court confirmation. That took another fourteen months. And in that time, the seller had cash flow problems, had to take on expensive bridge financing, and the nineteen million was stuck. Luna: So what finally happened? Lucas: The seller eventually got a court order. But by then, the seller had racked up legal fees, financing costs, and lost opportunities. The net loss was roughly nineteen million — which is the title of this episode. The scary part is, every clause that caused this is standard boilerplate in a lot of escrow agreements. Luna: So what should a seller actually negotiate? I mean, you can't always eliminate escrow. Lucas: Look, escrow is a legitimate tool. But there are three specific things to fight for. First, the release trigger should be tied to the expiration of the survival period, not to the resolution of claims. Second, the escrow should have a hard cap on the duration — say, twelve months, unless there's a pending claim that's actively being arbitrated. And third, the dispute resolution should require the arbitrator to issue a final award within a set time, and that award should be automatically binding on the escrow agent. Luna: And what about the interest? I've heard escrow accounts earn almost nothing. Lucas: That's another trap. The escrow agreement should specify that the funds are invested in a short-term treasury money market fund or something that actually yields. Otherwise, your nineteen million earns point zero one percent for three years. Luna: So the escrow is essentially a loan to the buyer at zero interest. Lucas: Exactly. And that's what people forget. When you agree to an escrow without interest, you're financing the buyer's balance sheet for free. Luna: That reminds me — we keep this podcast ad-free, and a lot of listeners have asked how to support it. If these conversations have moved your work forward in some small way, buying us a coffee is genuinely what keeps this going. It's a couple of dollars a month, and it makes a real difference — buy me a coffee dot com slash fexingo. Lucas: Yeah, and honestly, that support is what lets us keep digging into these real-world deal traps. So thank you for that. Luna: So back to the escrow — you mentioned the escrow agent. How much does the agent matter in this scenario? Lucas: Huge. In this case, the escrow agent was the buyer's bank. They had no incentive to release the funds, and they took a conservative interpretation of the release conditions. A good escrow agent — a neutral third party — would have seen the arbitration award and released the money. Luna: So the identity of the escrow agent is almost as important as the language. Lucas: Absolutely. You want an independent escrow company, not the buyer's bank. And you want the agreement to state that the escrow agent is an agent of both parties, not just a custodian. Luna: What about the size of the escrow? Is ten percent reasonable? Lucas: Ten percent is typical for a deal where the seller is taking some risk. But in a clean deal with solid due diligence, you can often get it down to five or even three. The key is to tie the escrow to the actual indemnity exposure, not the full purchase price. Luna: And how do you estimate that exposure? Lucas: You look at the warranties and reps, the specific risks in the business, and the likelihood of a claim. If the business is clean, you argue that the escrow should be minimal. If there are known issues, you might agree to a larger escrow but with a clear sunset. Luna: So the escrow is really a negotiation lever, not a fixed rule. Lucas: Right. And the smartest sellers use the escrow as a way to get a better price. 'You want ten percent escrow? I'll take it, but I want ninety percent of the purchase price in cash at closing, and the escrow only covers specific, named risks.' Luna: That makes sense. So the takeaway is: read the escrow agreement, understand the release mechanism, and never let it become an open-ended holdback. Lucas: Exactly. The escrow is meant to protect the buyer against unknown liabilities, not to give them a free float. And in this case, the seller lost nineteen million because they didn't read the fine print. That's the lesson. Luna: And that's the kind of thing that keeps me up at night if I ever sell my business. Lucas: Yeah, but now you know the questions to ask. And that's the whole point of this show.