Escrows and holdbacks.(Mergers, IPOs, and Venture Finance: Equities)

In every acquisition, there's always a nagging doubt about possible skeletons in the seller's closet. Are the receivables really collectible? Is there a lawsuit or product liability case waiting in the wings for a buyer with deep pockets? Because of concerns like these, acquirers are usually reluctant to write a check for the full purchase price at closing. Instead, they may insist on setting aside part of the purchase price to cover post-deal liabilities.

This amount is typically structured either as a "holdback" (the buyer writes another check at the end of the holdback period) or as an "escrow" (the buyer deposits funds in escrow at the closing, to be released at the end of the escrow period). Surprisingly, most CFOs prefer to put money into escrow instead of hanging on to the cash themselves. From their perspective, they've already allocated the funds, which are governed by a separate escrow agreement. When the time comes to settle up, the CFO doesn't have to come up with the cash to write a big check.

From the seller's perspective, the biggest concern about holdbacks and escrows is "death by a thousand cuts"--that is, the risk that the buyer will make many, many small claims that substantially reduce the final payout. To minimize this risk, buyers will usually agree to limit their right to claim funds from the escrow. Buyers generally agree to a "de minimus" threshhold for each claim, typically north of $10,000, along with an aggregate "basket" (anywhere from $50,000 to $500,000). The basket is the amount that the buyer's total claims must add up to before they can go after the holdback or escrow. Sharp-eyed sellers will also want to know whether their basket "tips over." A basket that tips over allows the buyer to recover the full amount of the claim, including the amount of the basket. A basket that doesn't tip over allows recovery for only the amount over the basket. A good-faith buyer will agree to substantial baskets and minimums, because they recognize that recoveries against escrows and holdbacks are their defense against major problems, and not a way to slice up the seller's equity.

Nat Burgess, senior vice president, Corum Group, 10500 NE Eighth St., Bellevue, Wash. 98004; 425/4558281. E-mail: nburgess@corumgroup.com.

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