Escrow hold-back + seller note = no deal?

searcher profile

August 10, 2021

by a searcher from New York University - Leonard N. Stern School of Business in West Chester, PA, USA

During the LOI negotiation process, we were accused of "double-dipping" because we proposed a seller note###-###-#### % of purchase price) and, separately, an escrow hold-back (5% of purchase price) to protect against a potential R&W breach post-close. The seller note is not structured as a "forgivable" seller note. Furthermore, we proposed that, assuming no R&W breach, the amount held in escrow would be released to the seller after 12 months. Are we being unreasonable by proposing a structure that includes a seller note (with no attached contingencies) and a 5% escrow hold-back? Any guidance and/or color would be greatly appreciated. Also, does anyone know of a source that has data on the use of escrow hold-backs in the lower middle market? Thank you!




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commentor profile
Reply by an investor
from University of Pennsylvania in Charlotte, NC, USA
In agreement with most others here. Having both provisions in a transaction is not uncommon. A non-contingent seller note is simply a deferral of a portion of the purchase price. An escrow (usually) is intended as a funding mechanism for purchase price adjustment post close and/or indemnity claims. There are occasionally separate escrows with different terms for PPA vs reps and warranties indemnification. If you were providing for a set-off against the seller note to fund indemnity claims (which I inferred is not your case), then seller could indeed consider this provision as a near-equivalent to a true escrow and additive to your proposed 5%. We have done transactions with various combinations of tailored seller financing and escrows. In one variation of a set-off, the amount in settlement of an indemnity claim could reduce the note's final payment if there is a balloon at maturity but would not affect the periodic principal and interest payments to seller. Obviously, that sort of arrangement depends on specifics of the transaction.

Can't comment on the appropriateness of the percentages you proposed without considerably more information. SRS Acquiom (mentioned in a previous post) is one source on "what's market" deal terms, and there are several others. Be careful relying on any of them too much. "Market" depends greatly on deal size and type, nature of the parties, and so on.
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Reply by an intermediary
from The University of Chicago in Chicago, IL, USA
Both can coexists, However, difficult to say if yours is reasonable b/c there are many variables 1) price multiple, 2) seller note %, 3) seller note amortization period, 4) asset value (i.e. low goodwill or high goodwill), 5) % holdback, 6) nature of business (prior history of law suits, warranty, and more), 7) quality of financials (% add-backs vs reported), 8) type of R&W, 9) buyer type (litigious, large corp., depth of DD), and more.
In M&A, there are guidelines but no hard and fast rules b/c there are too many variables. Examples: We currently have an LOI with respectable multiple, 100% cash with 15% holdback. Another one with R&W insurance and very small holdback.. One more: no holdback but with a 15% seller note + 5% stand-still.
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