ESCROWS IN CALIFORNIA BUSINESS SALE TRANSACTIONS
Business Sale Escrow
In California, for smaller business sale-purchase transactions, it is common to have an escrow agent serve as a neutral holder of funds and documents, communications link and closing facilitator. The escrow agent ensures regulatory compliance, prepares routine transaction documents and closing statements, and handles administrative details in a cost-effective manner. Business sale escrows protect the interests of buyers and sellers, and are used extensively by transaction attorneys and intermediaries in California.
Business sale escrow companies in California are either attorneys acting in a neutral capacity, or are licensed by the California Department of Corporations.
How a Business Sale Escrow Works
Escrow starts with a written agreement between the buyer, seller and escrow holder. The escrow holder prepares written escrow instructions* that reflect the terms of the purchase agreement and all conditions of the transaction. The buyer and seller will sign the escrow instructions, and make any necessary earnest money deposits. The escrow holder processes the escrow in accordance with the instructions. When all conditions are met, the escrow will be “closed”. The escrow holder provides a concise accounting of funds, and arranges for the safe delivery of all funds and documents to their proper recipients.
* When applicable, the instructions include a Notice to Creditors of Bulk Sale. California’s Bulk Sale law is contained in Commercial Code Section 6101-6111.
Typical duties of escrow holders in business asset sale/purchase transactions:
- Requesting publication, recording and UCC lien searches for state and county
- Complying with Bulk Sale statutes (publication), as applicable
- Notifying the county tax collector
- Requesting a beneficiary’s statement if debt or financial obligations are to be taken over by the Buyer
- Requesting demands from existing lien-holders, receiving claims
- Notifying and obtaining clearances from County, State and Federal agencies as required
- Complying with lender requirements, securing loan documents and receiving funds
- Obtaining and holding purchase funds from the buyer
- Prorating taxes, interest, rents, security deposits, etc., as instructed
- Preparing routine legal and financial documents such as notes, security agreements, personal guarantees, amortization schedules, deeds of trust, UCC-1 financing statements, bill of sale, corporate resolutions, etc.
- Can prepare fictitious business name statements
- May prepare routine amendments to agreements
- Securing releases of all contingencies or other conditions imposed on the escrow
- Preparing estimated closing statements for both parties (an accounting of funds to be deposited and disbursed)
- Consultation regarding problems that arise
- Preparing final closing statements
- Obtaining appropriate signatures on all documents
- Close escrow when all instructions of buyer and seller have been carried out
- Disbursing funds, including payments to third parties (commissions, lien payoffs, etc.)
- Preparing and recording UCC-1, UCC-3 and deeds of trust, as needed
- Securing tax clearances
- Distributing final transaction documents to the parties
Tasks performed in an actual asset sale/purchase transaction will vary. Stock sale escrows are quite different; typically simpler.
In business acquisition transactions, the buyer and seller often agree to place a portion of the purchase price in a third-party escrow account for a specified period of time after closing to secure payment of certain items. Holdback escrows go by other names, such as “indemnity escrow” and “holding escrow”. Both buyers and sellers can benefit from holdback escrows.
Funds are typically held to:
- Indemnify the buyer against losses caused by a breach of the seller’s representations, warranties or covenants;
- Pay post-closing working capital or balance sheet adjustments;
- Guaranty payment of an earn out (where part of the purchase price is based on post-closing performance of the business);
- Insure the performance of some other event by the seller; or
- Some combination of the above.
A holdback escrow holder may be a bank, trust company, or other professional service provider. A holdback escrow requires an agreement between the holder, buyer and seller, which includes, among other things, conditions for releasing funds and procedures for resolving disputes. This can take some time to negotiate. Holdback provisions should be carefully thought out and negotiated early in the M&A negotiation process. Understanding common pitfalls and best practices only comes with experience.
The holdback escrow and transaction escrow are mutually exclusive. When both types of escrows are used in a transaction, one provider generally provides both services. In some cases, however, funds from a transaction escrow roll over into a separate holdback escrow account upon a transaction closing.