Escrow sounds like legalese, but it’s actually simple. It’s money held by a neutral third party (usually an escrow agent, bank, or attorney) instead of being paid directly to you at closing. The escrow agent releases the money after certain conditions are met.
Escrow is a standard part of business sales, and it protects both you and the buyer. The buyer wants some protection if things go wrong after closing. The seller wants assurance that the funds actually exist and will be released.
How Escrow Works
Here’s the mechanics. You and the buyer agree on a purchase price, say $500,000. Instead of the buyer handing you $500,000 at closing, they might do this:
- $425,000 paid directly to you at closing
- $75,000 held in escrow for 90 days
On closing day, the buyer’s money goes to the escrow agent, not to you. The escrow agent holds it in a separate, interest-bearing account. After 90 days (or whatever period is agreed), if there are no disputes or claims against the escrow, the agent releases the money to you.
The escrow protects the buyer because if they discover after closing that you materially misrepresented something—say, revenue was actually 50% lower than claimed, or there’s an undisclosed liability—they can file a claim against the escrow before it’s released. If the claim is valid, the escrow money stays with the buyer to compensate for the loss.
Why Escrow Exists
From the buyer’s perspective: they’re buying a business without perfect information. Even after due diligence, surprises happen. Within the first 30 days of ownership, they might discover financial discrepancies or hidden liabilities. Escrow gives them a window to address those.
From your perspective: you want the buyer to take the deal seriously and actually show up with the money. Escrow ensures the money is real, locked in, and will be paid assuming everything goes smoothly.
It’s a middle ground. The buyer can’t just walk away and keep the money. You can’t claim it’s not available. An escrow agent holds it until conditions are met.
Typical Escrow Terms
Most escrow agreements specify:
Amount — Usually 5-15% of purchase price. $500,000 sale might have $25,000 to $75,000 in escrow. Larger amounts mean more protection for the buyer but more risk for you.
Duration — Usually 30-90 days, though up to a year is possible. Longer durations give the buyer more time to identify issues but delay your full payout.
Release conditions — The standard is: “Release to seller unless buyer has filed a claim before the release date.” Some agreements require that any claims be resolved; others release funds after the duration even if a claim is pending.
Dispute resolution — How are escrow disputes resolved? Do you arbitrate? Go to court? Can the escrow agent release funds if both parties agree, or does it require a court order?
The nuances here matter. A 10% escrow for 90 days is standard. A 20% escrow for a year is aggressive and puts a lot of your money at risk for a long time.
Negotiating Escrow Terms
When a buyer proposes escrow, don’t just accept it. Here’s how to negotiate:
Negotiate the amount. If they propose 15%, offer 10%. If your financials are clean and well-documented, make the case for a smaller escrow. “I have three years of audited financials and clean disclosure. I’m comfortable with 10% escrow.”
Negotiate the duration. Suggest 30-45 days instead of 90. The longer the duration, the longer you’re not getting paid in full. A shorter duration shows the buyer you’re confident the business is what you represented.
Negotiate what triggers a claim. Most agreements say the buyer can claim against escrow for any breach of the seller’s reps and warranties. Some limit it—for example, no claim unless it exceeds $10,000 or affects more than 5% of EBITDA. Those thresholds protect you from frivolous claims.
Get clarity on release. Some escrow agreements require both parties to agree to release, which means if there’s a dispute, the funds stay in escrow. Others release after the duration if no claim has been filed. The latter is better for you.
Negotiate interest. Escrow money usually sits in an interest-bearing account. Agree upfront: does the interest go to you or the buyer? Typically it goes to you as the seller.
The Problem Cases
Escrow disputes happen when a buyer claims something was misrepresented. They say revenue was lower, or there was an undisclosed liability, and they try to claim against the escrow to compensate.
Here’s the risk: escrow money can disappear in legal disputes. If you and the buyer are arguing about whether a customer contract was actually breached, the escrow might stay frozen while lawyers fight it out. Six months later, you still haven’t gotten the escrow money and you’re paying legal fees.
This is why clean, well-documented financials matter. If your numbers are audited or reviewed, if you’ve disclosed everything, and if there are no hidden issues, you’re confident in your disclosures and you should push for a smaller escrow and shorter duration.
Best Practices
Before closing, get all your reps and warranties in writing. Make sure you understand what you’re representing and standing behind. If you’ve misrepresented something accidentally, fix it before closing rather than dealing with an escrow claim later.
Ask the buyer upfront: “What could trigger an escrow claim? What are your concerns?” If they have specific concerns, address them. “You’re worried about customer retention? Here’s a list of our customers and the length of their contracts.” That reduces the risk of claims.
Keep documentation organized and accessible. If an escrow dispute arises, you need to quickly prove your representations were accurate.
Escrow is normal and reasonable. Buyers should have some protection. But don’t accept overly aggressive terms. A 10% escrow for 45 days is standard. A 20% escrow for a year is worth pushing back on. Negotiate terms that feel fair to both sides.
And remember: the escrow protects the buyer from discovering something false after closing. If you’ve been transparent and honest, the escrow should be released without issue and you’ll get the funds on schedule.