Escrow is a neutral third-party account that temporarily holds funds from a transaction until specified conditions clear—most common as a holdback in acquisitions.

How it works

In a stock purchase agreement, the buyer may withhold 5–15% of purchase price (varies by deal) in escrow for 12–24 months. Purpose: backstop seller indemnities—breaches of representations about IP, financials, contracts, or litigation.

If a claim arises (e.g., undisclosed tax liability), buyer notifies escrow agent; disputed amounts follow resolution procedures. Unclaimed escrow releases to sellers at term end.

Escrow differs from earn-out (performance-contingent) though both delay cash. Some deals combine both. Venture rounds occasionally use escrow for milestone tranches or disputed closing conditions.

Example: $100M acquisition, 10% escrow ($10M) for 18 months. Founders receive $90M at close; $8M releases at month 18 with no claims; $2M paid to buyer for a customer contract breach found post-close.

Why it matters

• Founders: Escrow hits personal and investor proceeds unevenly depending on waterfall and recourse caps. Negotiate baskets, deductibles, and survival periods for reps.
• Investors: Preferred may receive escrow proceeds first; disputes between buyer and seller drag liquidity.
• Buyers: Escrow substitutes for chasing sellers after close—critical when founders leave.

Common mistake

Assuming escrow always returns in full. Material rep breaches—even disputed ones—can tie up funds in legal process. Budget taxes and personal plans on net-at-close cash, not gross headline.

Related ideas

• Indemnification — legal promises escrow backs
• Earn-Out — performance-linked deferred pay
• Enterprise Value Bridge — escrow as deduction
• Rep and warranty insurance — alternative to large escrow