Escrow mechanics

September 08, 2024

by a searcher from Duke University - The Fuqua School of Business in Denver, CO, USA

I've been reading conflicting things and I'm not sure if it's due to a change in SOP or something else, so rather than confusing myself more, I was hoping to ask for some guidance.

I had a confusing call with a broker where he said if your escrow as a % of your purchase price goes from 15% to 5% (let's say the original IOI was 15% and the buyer wants to drop this to 5%), the buyer would need to put up considerable more of their own money. I was thinking back on our conversation and I then started questioning what he meant.

Let's say the purchase price is $8M, the seller will rollover $1M, the buyer will contribute $1.5M, and that leaves $5.5M to be financed. Of the $7M (price - rollover), let's say in scenario A $1,050 is held in escrow and scenario B $350k is held in escrow. I thought escrow holdbacks are eligible for SBA financing as long as it's not based on an earnout, maybe I'm wrong here?
In Scenario A vs B, is the only difference the seller will receive less money up front in A or are there other nuances involved?
Apologies, this is probably a simple question but I wanted to be a little more clear on escrow mechanics and when the seller actually receives funds. Thank you.

Reply by a lender
from Eastern Illinois University in 900 E Diehl Rd, Naperville, IL 60563, USA

I would be happy to jump on a call to discuss. Unfortunately I am not 100% sure what you are getting at. What I can tell you is that many lenders do not like to use escrows and the SBA does not like them either. Usually if there is an escrow the lenders do not want them to go beyond one-year and the lender wants to be the beneficiary of the escrow, meaning if you get any money back from the escrow it then goes back to the lender to pay down your loan. The SBA does not allow the Bank to fund money into an escrow that can then come back to you as additional capital and in essence give you cash back on the transaction. If those funds come back they must come back to pay down the loan. I hope this helps to clarify. You can reach me here or directly if you have additional questions.

Reply by a searcher
from Concordia University in Toronto, ON, Canada

You would need to finance all that $7M at closing. However, you transfer the escrow amounts to your lawyer's trust account. Those will be released to the seller subject to certain conditions within an agreed timeframe. So basically the seller will receive $7M less the escrow amounts at closing and will receive the escrow amounts later net of any claim you may make during the escrow period.
If you mean to use vendor financing or holdback as an escrow, then your financing will be lower proportionally but you will need to fund them at the end of the escrow period (or vendor financing period).
I suggest you prepare a source & use table for your deal and another source and use table for the buyer, from buyer's point of view.

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