Mergers and acquisitions (M&As) are a standard type of transaction in the business world, and of course, in deals that are complex, there are all sorts of instruments used and stipulations demanded from the participants. Many of these are financial, and one of the frequently used items in these business dealings is escrow in M&A.
What Is Escrow?
A common business term, escrow is when money or other assets that are part of a transaction between two parties are held by a third party. An escrow agreement is mainly done when two parties are in the midst of a transaction and have its funds “on hold” for any number of reasons, commonly as collateral or proof that “the money is there.” During the course of the transaction, the party that holds the escrow fund or assets is known as the escrow agent. The funds are held in a separate account, which is called an escrow account.
Escrows in M&As
M&As are legal transactions in which two companies (or divisions thereof) perform a consolidation of assets. The reasons for doing an M&A transaction are numerous — mostly financial or business-related — but in most cases, the end result is to create value. So, in short, M&A is a process, in basic terms, that results when two companies combine with one another. In addition, there are other types of M&As, including tender offers, acquisitions of assets and management acquisitions.
So, what is escrow in M&As? Escrow M&A, as described above, is simply a risk mitigation tool — one that guarantees that the assets stated in the agreement are readily available. The primary use of escrow in an M&A transaction is to lessen the due diligence costs and manage the perceived risk between the buyer and the seller.
How Escrow Is Used in M&As
There are a few main reasons why an escrow service is used during the M&A process, and these include the following:
Indemnities and Warranties
Funds held in escrow help assure all parties that any funds are available to meet the covenants. This helps lessen the due diligence phase, as the escrow provides indemnities, representations and warranties on behalf of the target.
Show of Good Faith
Because of the time, money and effort being invested into the deal by the seller, an escrow agreement is a show of good faith on behalf of the buyer. The escrow fund can be released to the seller in case the buyer backs out of the deal.
Possible Adjustment of Term
In the event of a change in terms in the agreement (such as the purchase price), these funds can be held in the escrow account and held until the final figures are agreed upon.
Approval
When a third-party to the transaction (not the escrow agent, however) has some say in the matter (such as a governmental regulatory agency that needs to approve the merger, for example), the purchase amount can be placed in an escrow arrangement, only to be released when approval is granted.
Who Benefits from Escrow in M&As?
Both the buyer and seller can benefit from an M&A escrow arrangement. The buyer benefits by having the funds readily available for multiple purposes, including not having to deal with obtaining the funds by any other means. An M&A escrow transaction also helps expedite the process, which results in lower transaction costs.
The seller benefits by knowing exactly what proceeds it will receive at the conclusion of the transaction. In addition, the funds held in an escrow service are its only recourse for non-fundamental breaches, which means the seller can draw from the funds in the event of some sort of claim related to a loss. Plus, an escrow transaction helps to use these funds to repay any buyer claims for post-closing losses, rather than to pay these costs from any other source.
Additional advantages include an increase of proceeds received by the seller and increased value to the buyer.
Virtual Data Rooms for M&A Deals
A virtual data room (VDR) is an online location, a place where companies store (and share) confidential information in a “workspace” for all M&A transactions, including those that involve escrow. In many cases, it’s employed during the due diligence stage of the deal. Part of maintaining data integrity in escrow transactions is the ability to maintain permissions and monitor who is able to access the data. It also tracks what parties have accessed and/or edited what specific documents. And because the VDR is the central repository for the information required for the business deal, administrators can set user- and group-specific permission on all documentation.
In addition, the contents of a VDR can be maintained for future access, which allows users to see who viewed and/or edited any documents during the escrow portion of the transaction. A VDR is certainly an important part of any M&A transaction that delivers a secure, online vault for storing and sharing documents, and its controls provide access privileges for the legal, financial and other parties involved in the business deal.
CapLinked Solutions
CapLinked, a leader in the VDR space, provides virtual data rooms for users working in M&As in multiple industries. Its cutting-edge features include document and version management, high-level administrative controls, multiple layers of security, encryption and 24/7 customer support. And because its user-friendly interface is compatible with virtually every OS, users can upload, edit, and download documents from every type of computer, smartphone, or tablet. To learn more about how CapLinked can help expedite and lower the cost of your M&A with a virtual data room, start a free trial today.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.
Sources
Elemental – M&A escrow
Corporate Financial Institute (CFI) – Escrow
