Adjustment of purchase price
Where the purchase price is likely to be adjusted, for example by way of completion accounts or an earn out, a portion of the purchase price can be placed in escrow, subject to finalisation of the relevant metrics.
Government approval/conditional completion
Where completion is conditional upon a third party event, most commonly approval of a government authority, such as the competition commission, some or all of the purchase price can be placed in escrow, subject to such approval.
Advantages of an Indemnity/Warranty Escrow
Escrow arrangements are often most valuable when they are used in the acquisition of an entire private firm, rather than the acquisition of a subsidiary of a larger group (where the buyer would have recourse against the remaining group for an indemnity/warranty claim). As a result, escrow contracts are used in 65% of private firm acquisitions compared with only 32% of subsidiary acquisitions.
Escrow arrangements are also particularly helpful when there is a large information asymmetry about the target’s value, between the buyer and the seller(s). For example, where the buyer is not an expert in the trade of the target. Such information asymmetry increases the transaction risk for the buyer and, consequently, the due diligence costs of the transaction.
Academic research has shown the following benefits of using an escrow arrangement:
- 50% reduction in due diligence costs: Use of an escrow arrangement can reduce the time spent on due diligence by an average of 50% and the benefits are most likely to be seen when there is significant asymmetry in the knowledge of the buyer and the seller regarding the target.
- 6 % increase in proceeds received by the Seller(s): Even after allowing for potential claims on the escrow account, sellers typically receive a 6% increase in proceeds when an escrow account is used.
- Increased value to the buyer: Not all of the benefits from the escrow account are passed to the sellers and the share price reaction of public companies acquiring private companies using an escrow arrangement is more positive than those not using one.