In an uncertain world, safeguarding assets in an escrow arrangement by an independent third party provides financial security for both the buyer and seller. CSC’s Jaap Veerman and John Cuciti explain more.
Larger and ever more complicated M&A deals have prompted increased scrutiny and stress-testing of targets. This sometimes leads to litigation and pricing adjustments. Against this backdrop, specialized escrow services have become a critical piece in the deal-making puzzle, as well as being an anti-corruption prerequisite in some jurisdictions.
In the U.S., it’s a common business practice to use an escrow account administered by a trusted and independent third party in any sale or acquisition. Europe has been slower to adopt that practice. However, over the past decades, as both buyers and sellers began to see the benefit of having robust financial security and payment protection in place during the M&A process, escrow accounts have become more commonplace.
How does an escrow account work?
The primary purpose of a third-party escrow arrangement is to protect both buyers and sellers regardless of the size and complexity of the deal. The complex nature of an M&A transaction lends itself to the need for escrow services, especially when you consider the added complexity of deals with cross-border implications. They are often put in place during the due diligence process as a safeguard, should the buyer discover irregularities or uncertainties in the financial condition of the target company.
Issues might be revealed during the course of investigating and valuing a company’s assets and liabilities, reviewing revenue declarations and forecasts, checking on the possession and retention of licenses, or with regard to legal, tax, environmental, and regulatory issues and exposures. If irregularities are detected, negotiations may need to be reframed, perhaps with a reduced purchase price, or with new conditions of sale put in place.
In the above scenarios, it’s a prudent business practice to set aside a portion of the purchase consideration in a segregated escrow account to safeguard funds until certain agreed upon conditions of sale are met. Escrow funds are only disbursed upon instruction in accordance with the terms outlined in the escrow agreement. So, for example, if the purchase price was $100 million, both buyer and seller might agree for $10 million to be deposited in escrow, only to be released when the accounts were found to be genuine and without irregularities.
Using an escrow account to manage and mitigate M&A risk
An escrow arrangement can also be used to protect against future uncertainties and risk relating to a target. As recent political and economic events have shown, we live in an unpredictable world and many risks are unforeseeable.
For example, lawyers and accountants may find risks relating to financial profits for the coming year. Or there may be a question over whether all accounts receivable are collectible, what taxes are due, whether penalties or environmental risks arise, and whether licenses are coming up for renewal. To avoid any unexpected outcomes, the seller and purchaser can agree on a hold-back amount to cover any identified uncertainties.
Escrow arrangements protect businesses against unknown risks that might occur after a takeover or during the closing process, as money is disbursed to the sellers. Although there’s no obligation to use an escrow account when putting together a deal, there’s also no sense in making a deal without this level of financial security.
How CSC can help
CSC is a reputable provider of corporate trust and agency services with a great deal of experience, global reach and high-quality customer service. Our global escrow capabilities support large and small public and private companies around the world through our regional hubs located in the United States, Netherlands, and the United Kingdom. In Europe, we have a European and United Kingdom Payment Services Directive license which allows us to set up regulated escrow agreements in all European Union countries, including the United Kingdom. As a result, escrow accounts can be set up under a number of different governing laws in the U.S., EU or U.K.
Our dedicated team of highly experienced personnel can manage your global and local deal requirements including cross border transactions. We can also support blocked account agreements and paying agency mandates. These may involve the disbursement of funds to hundreds of sellers in various currencies and require cash management expertise, operational excellence, and good communication skills to help lawyers and all parties set up the arrangement in a short time frame.
Visit our website and get in touch for more information and talk to our expert team today.
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