A holdback is the amount of the purchase price that is not paid at the time of closing. This money is typically held in a third-party escrow account (generally the seller’s) to protect a future obligation or to meet a specific condition.
In buy and sale agreements, holdbacks are fairly prevalent. Most sellers expect them to provide clarity in areas that aren’t completely understood at the time of closing. The majority of the time, these holdbacks are related to meeting a specified working capital level or if there is still litigation pending at the time of closing.
Holdbacks are frequent in transactions, so sellers shouldn’t be startled if a buyer requests one. Holdbacks, on the other hand, should not exceed 5% of the purchase price and should be limited to issues that may be remedied quickly after the transaction closes.
Do You Need a Holding Escrow Account?
There are some situations where a holdback is appropriate, and others where it is not. For example, if a seller holds back a considerable portion of the purchase price to encourage the seller to meet a specific post-closing EBITDA target (earnings before interest, taxes, depreciation, and amortization), the transaction term is an earnout rather than a holdback. Working capital thresholds are where holdbacks are most routinely applied.
A seller will frequently demand that a specified amount of net working capital be supplied at the end of the transaction. Working capital is often estimated at this point, with full accounting done 30–60 days after the deal closes. The holdback will shield the buyer from any accounting differences between the expected working capital at close and the actual, final accounting working capital. If the buyer’s operating capital falls below the threshold at this time, the holdback protects them by deducting the difference from the holdback repayment.
If the target company is involved in outstanding litigation at the time of closure, a holdback is often used. The buyer will want an estimate of the potential loss from the lawsuit, and will either lower the purchase price or keep the predicted loss amount as a holdback until the lawsuit is resolved. Contact us now if you think you could benefit from our holding escrow services.
