As M&A activity continues to navigate complex market conditions, escrow arrangements have become indispensable for facilitating successful transactions.
This is particularly true in scenarios where founders, management teams, or other private individuals lead the exits. These types of deals often present unique risks for buyers, particularly when traditional warranties and indemnities (W&I) insurance provides limited or incomplete coverage. Escrow offers a practical solution, helping both parties secure recourse options and mitigate post-transaction liabilities in an unpredictable environment.
Certainty of Funds in an Evolving M&A Landscape
In recent years, a significant proportion of M&A transactions have involved founders or management teams as sellers. Whether it’s a founder stepping away from the business or a management buyout, these deals can leave buyers exposed to potential financial risks if post-transaction claims arise. The certainty of funds, therefore, becomes a critical aspect of these transactions. Without it, buyers could face challenges in pursuing recourse, especially when sellers are individuals with fewer available assets. Escrow provides an essential safeguard, ensuring that funds are set aside to cover any potential claims or indemnities after the sale.
Furthermore, escrow plays a crucial role when certain liabilities aren’t covered by W&I insurance. While W&I insurance is often used to protect buyers from unforeseen risks, it doesn’t always provide full coverage. For example, exclusions for environmental or legal risks identified during due diligence can leave gaps in the buyer’s protection. In other cases, the cost of obtaining comprehensive insurance is prohibitive, leading to partial coverage. In both scenarios, escrow steps in to provide the security buyers need, holding funds to address any liabilities that fall outside the insurance scope. Additionally, escrow can serve to hold deposits or reverse break fees, ensuring funds are available if a deal is unable to close due to regulatory or competition authority issues.
Escrow as a Strategic Tool for Risk Management
As deal complexity increase, escrow continues to serve as a versatile tool to manage risk allocation between buyers and sellers. It ensures that funds are available not only for W&I claims but also in situations where the final purchase price is subject to adjustment. In many transactions, particularly those involving completion accounts, escrow allows parties to securely hold a portion of the transaction value until the final adjustments are agreed upon. While some markets favour the locked box mechanism for its simplicity, escrow remains a preferred option for deals where completion accounts provide a clearer picture of the company’s financials at closing.
In addition, escrow is frequently employed when transactions are subject to regulatory approvals. If a deal is contingent on approval from a competition authority and fails to obtain the necessary clearance, escrow can be used to hold reverse break fees, ensuring sellers are compensated for the buyer’s inability to complete the transaction. This is becoming increasingly important as regulatory scrutiny intensifies across various jurisdictions.
Escrow’s Growing Role in Today’s M&A Environment
As the M&A landscape becomes more intricate, escrow arrangements are increasingly relied upon to manage various risks. Whether facilitating founder-led exits, management buyouts, or corporate acquisitions, escrow ensures that both parties have a clear and secure path to meeting financial obligations. The size and scope of escrow funds often reflect the complexity and risk profile of the deal, offering flexible solutions to accommodate a wide range of transaction structures.
Conclusion
In today’s M&A environment, escrow arrangements have evolved into a crucial component of deal structuring. They provide the security needed to navigate uncertain liabilities, ensure price adjustments, and manage regulatory contingencies. As more transactions turn to escrow for risk management, its role in shaping successful outcomes remains indispensable.
For further information on JTC’s escrow services, please visit our dedicated webpage or contact Dewi Habraken or Eke Verbeke directly.
