What Are Escrow Holdbacks?

Generally speaking, an escrow holdback, or simply a holdback, is a portion of the purchase price that is not paid to the seller at closing. Instead, it is usually delivered to an escrow agent, the neutral, third party dedicated to holding the funds until specific, agreed-upon events that have been agreed upon by the buyer and seller occur. Escrow holdbacks are common in business mergers and acquisitions and in the purchase of real estate.

Within mergers and acquisitions, escrow holdbacks can be used for:

  • Earn outs – Whereby the buyer sets aside a certain amount to be paid to the seller upon hitting specific revenue targets within a specific time period.
  • Pending litigation – Where the Buyer will need to account for a potentially unfavorable ruling against the company being purchased. The unfavorable ruling could result in a downward adjustment of the purchase price, resulting in a refund of the amount held by the escrow agent.
  • Breaches of representations and warranties – Seller and buyers will sometimes agree to place limits on certain contracted items by placing funds in escrow.

In the acquisition of real estate, holdbacks are commonly used for:

  • Improvements – Buyers and lenders will often require that a certain amount be held in escrow to cover needed improvements to the target property. In these circumstances, the seller will not receive the full purchase funds from escrow until the required improvements are complete.
  • Post-closing occupancy – In some cases, the Seller may occupy the premises after closing has occurred. Buyers should protect themselves by holding back a certain amount as rent/lease or to account for any damage to the property.

Regardless of the type of transaction, it is critical to negotiate the terms of the holdback, including the rights and obligations of each party to the holdback. Mutual understanding of the post-closing activities, including the selection of an experienced escrow agent, can help complex transaction go much more smoothly.