The Ins and Outs of Escrow
Ah, escrow: the classic independent 3rd party. Essentially escrow is the Switzerland of the business and transactional world. As a neutral third party and legal fiduciary, an escrow company can potentially play several roles in your business transaction. The reality is, though, that a lot of companies don’t need to use escrow throughout the process.
Which brings up the question, why would you need the proverbial Switzerland when selling your business?
Roles of an Escrow Company
Before we dive into the different scenarios that make an escrow beneficial, let’s cover some of the different actions an escrow company can take on your behalf or complete as part of the transaction process.
First, know that an escrow company executes actions based on a set of instructions that they are given. Those instructions are outlined and agreed upon by the buyer and seller before any work is performed. Once the instructions are signed, sealed, and delivered, so to say, the escrow company cannot deviate from the plan unless both parties agree on a new set of instructions. This is really important. Ensure that the instructions given are exactly what needs to take place.
The primary role of escrow is to hold onto documents and money until both parties reach the point or date where the monies and documents can exchange hands. That’s why an escrow company holds the money and deed in a real estate transaction. Both the buyer and seller need to know that the other party is fulfilling their obligation but the seller wants to an inspection before handing the money to the seller. Once the inspection is complete and any updates are agreed on, the assets can transfer out of escrow.
In addition to holding monies and documents, an escrow company can get a tax clearance from both the state and federal government. This includes sales tax clearance for businesses with a retail license. They can also do a UCC-1 check to verify if there are liens on any properties.
An attorney is also legally allowed to perform all the roles of an escrow company and is typically used if the transaction is simple. Stock purchases don’t usually have the Bulk Sale notification requirements and the attorney can hold the deposit in their trust account. Typically, owners will turn to an escrow company when the attorneys are not located locally or it’s an asset sale.
Small Transaction Examples
Asset sales less than $500,000 typically utilize an escrow company. The escrow company checks for any liens, as well as holds the earnest money until everything clears. This also gives time for the seller to adhere to the bulk sales laws, when necessary, which include notifying creditors and publishing notices about the sale of the business.
Small stock sales will also use escrow companies to hold stock certificates, earnest money, and check tax clearances.
Long-Term Payout Examples
Occasionally, new buyers want reassurance that everything is as it was promised once they “look under the hood.” One way we help structure this deal is to have a payout over a length of time. For example, if the business sells for $750,000, you could pay $250,000 at closing and then $250,000 for the next two years. The buyer would put the $500,000 into escrow to prove they had the funds, and the escrow company would pay the owner the following two years as longs as the stipulations agreed on were met.
There are several different scenarios that may lead to a multi-year payout, including a creative tax strategy.
Discovering the Best Option for Your Business
As we mentioned, not every transaction will employ an escrow company. It depends on the specifics of the transaction. At Exit Consulting Group, we work with business owners on all aspects of the business sale.
In truth, whether or not you use an escrow company is a minor detail in a very long and complicated selling process. When you partner with our team, we take all of the guesswork out of the transition. From preparing the business for the market to crossing the finish line, we walk you through our proven process and handle all the little details that come up along the journey. That way you can devote your energies to what you do best: running your business.
If you’re thinking about selling your business in the next one to three years, contact us today.