In the final stretch of a business sale and purchase, buyer and seller face a tension that is difficult to resolve. The buyer fears that, once the price has been paid and ownership transferred, contingencies may arise — a tax audit, an employment claim, a customer complaint — whose origin lies before the acquisition but whose bill lands with him. The seller, having negotiated hard for the price, does not want to leave a significant portion of the proceeds hanging on risks he considers unlikely. The escrow is the tool that reconciles both positions and allows the transaction to close.
In this article we explain, from a practical middle-market M&A perspective, what an escrow actually is, how it works, what percentages and periods are customary, how it is negotiated and what pitfalls to avoid to prevent it from becoming a source of dispute.
What is an Escrow Account?
An escrow account is an account operated by an independent third party — the escrow agent, typically a bank, a specialised financial institution or a notary — into which a portion of the sale and purchase price is deposited until certain conditions set out in the agreement have been met.
Its function is to cover risks or liabilities that may surface after closing: legal claims, tax contingencies, employment liabilities or other risks which, notwithstanding the due diligence, had not been identified or fully quantified during the process. Rather than the buyer withholding those funds himself — which would give him an unbalanced position of strength — or the seller collecting 100% with the buyer bearing all the risk, a portion of the price is "frozen" in neutral hands.
The escrow is a mechanism for allocating risk. It translates the reasonable distrust between the parties into money and timeframes, and turns it into something manageable.
Why the Escrow is so common in M&A
The escrow is closely tied to the representations and warranties (reps & warranties) regime of the sale and purchase agreement. In the SPA (Share Purchase Agreement), the seller makes a series of statements about the state of the company (that there are no undisclosed litigation, that taxes are up to date, that the accounts reflect the reality of the business, and so on) and undertakes to indemnify the buyer if those statements prove inaccurate. The escrow is, precisely, the liquid security for that indemnification obligation: if a representation fails, the buyer collects against the deposited funds, without having to pursue the seller through the courts.
This connection explains why the escrow appears above all when there are identified but not conclusively quantifiable risks; when the buyer perceives a risk of future insolvency of the seller (for example, where the seller is an individual who is going to distribute the sale proceeds); or when the financial due diligence has detected specific contingencies — an open tax audit, ongoing litigation — that should be "covered" until they are resolved or time-barred.
How the Escrow works in practice: the three phases
- Buyer and seller agree on the amount to be deposited, the release conditions, the term and the agent. This is the decisive phase: a poorly defined escrow at this stage is a dispute scheduled to erupt two years down the line.
- Post-closing period. Following signing, the agent holds the funds in custody while the security period runs its course. Claims are resolved (or dismissed) during this time. The seller does not have access to the money, but neither is it in the buyer's hands: it sits with a neutral third party.
- If, at expiry, there are no claims outstanding, the funds are released to the seller (often together with accrued interest). If there are, the corresponding amount is withheld or paid to the buyer, and the balance is released. It is advisable for the agreement to provide for staggered partial releases, so that the seller does not wait years to receive the entirety.
Amount and term: what is standard in the mid-market
Although every transaction is different, there are market benchmarks in the Spanish middle market:
- Percentage withheld: typically between 5% and 15% of the price in standard transactions. It may be higher — exceptionally up to 50-70% — where there are specific risks of considerable magnitude or where the seller's solvency raises concerns.
- General term: between 12 and 24 months, which usually coincides with the survival period of the general representations and warranties and with the closing of at least one full fiscal year under the new ownership.
- Special periods: for tax risks, the escrow may extend to 3-5 years, in line with the tax limitation periods. It is common to agree a "principal" escrow of 12-24 months and a specific longer tax escrow.
The negotiation of these parameters is not mere bargaining: it reflects the allocation of risk between the parties and the valuation bridge itself, since the amount withheld conditions how much the seller actually collects at closing.
Escrow compared with other alternatives: W&I insurance and holdback
The escrow is not the only way of managing post-closing risk. Its two most common alternatives — or complements — are:
- Holdback (direct retention): the buyer simply defers payment of a portion of the price, without depositing it with a third party. It is simpler and cheaper, but leaves the seller exposed to the buyer's solvency and good faith.
- Warranty & Indemnity Insurance (W&I): an insurer assumes the risk of breach of the reps & warranties in exchange for a premium. This makes it possible to reduce or even eliminate the escrow, which the seller welcomes because he collects 100% at closing. It is increasingly common in private equity transactions and in sales to search funds, and generally in transactions of a certain size.
Choosing between escrow, holdback or insurance — or combining them — is a structuring decision that should be made with advice, because it directly affects how much the seller collects, when he collects it, and with what certainty.
Advantages, disadvantages and pitfalls to avoid
For the buyer, the escrow offers a quickly accessible financial cushion against post-closing issues, without litigation. For the seller, it lends credibility to his representations and facilitates (and accelerates) closing, while also conveying good faith.
On the other side of the ledger, it involves costs (agent's fees and account administration) and a risk of dispute over the release of the funds. Most escrow disputes are not born of the amount, but of ambiguous drafting: what counts as a valid claim, within what timeframe it must be notified, who decides whether it is admissible, and how a disagreement is to be resolved. A well-drafted escrow agreement defines with precision the claims procedure, the minimum thresholds (de minimis and basket), the maximum cap and a swift dispute resolution mechanism, ideally through an independent expert for purely accounting matters.
How Maraz Corporate Finance can help
The escrow is one of those elements on which a good part of the effective price of a transaction turns, and where poor structuring can turn a successful sale into a years-long dispute. At Maraz Corporate Finance we advise sellers and buyers on the structuring of M&A transactions, including the negotiation of the escrow, the representations and warranties and the entire valuation bridge, coordinating the due diligence that determines which risks should be covered. If you are preparing an acquisition or a sale and want to structure the guarantees properly, contact our team.
Javier de Rojas Roca de Togores
Partner – Maraz Corporate Finance
FAQs on Escrow in M&A Transactions
What percentage of the price is typically withheld in an Escrow?
In standard middle-market transactions, it is customary to withhold between 5% and 15% of the price. The percentage rises where there are specific risks of considerable magnitude or where the seller's future solvency raises concerns, reaching exceptionally 50-70%. The exact amount is negotiated by reference to the risks detected in the due diligence and to the balance of bargaining power between the parties.
How long does an Escrow last?
The general term usually ranges between 12 and 24 months, matching the survival period of the representations and warranties and the closing of at least one full fiscal year under the new ownership. For specific tax risks, the escrow may extend to 3-5 years, in line with the tax limitation periods. It is common to combine a shorter general escrow with a longer specific tax escrow.
Who holds the Escrow money?
An independent and neutral third party, the escrow agent, which is usually a bank, a specialised financial institution or a notary. Neither the buyer nor the seller has unilateral access to the funds: the agent releases them only when the conditions agreed in the contract are met. That neutrality is precisely what provides comfort to both parties and prevents the money from being in the hands of either of them.
What is the difference between an Escrow and Warranty & Indemnity insurance (W&I)?
In an escrow, it is the seller himself who backs the risk, leaving part of his money withheld. Under W&I insurance, it is an insurer who assumes that risk in exchange for a premium, enabling the seller to collect 100% of the price at closing while the buyer retains protection. The insurance is increasingly common in private equity transactions and deals of a certain size; the escrow remains the most widespread formula in the middle market because of its simplicity and lower cost. See our article on representations & warranties in M&A for more on this interaction.
What happens if a dispute arises over the release of the Escrow?
It depends on what the agreement provides, which is why drafting is critical. A well-crafted escrow agreement defines what counts as a valid claim, within what timeframe it must be notified, the minimum thresholds and the maximum cap, and establishes a dispute resolution mechanism — ideally an independent expert for accounting matters, and arbitration or the courts for legal ones. Most disputes are not born of the amount, but of ambiguous clauses, so investing in solid drafting saves litigation.
