May 5, 2022
Why You Need a Business Sale Escrow When Closing Deals
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Business sale escrow is one of those issues that might come up when you’re selling your company. While it’s not always a requirement, all legitimate business brokers will strongly advise you to secure your sale transaction with an escrow agreement.
Beacon, for instance, has always insisted that both buyers and sellers ought to leverage business sale escrow in their dealings. Even when our experts help you with business valuation, buyer pre-qualification, and purchase agreement negotiations, they’ll still emphasize the need for setting up an escrow account that serves both parties.
You see, a person’s word is not enough when it comes to the intricacies of business sale transactions. There are many things that could potentially go wrong even when you’re dealing with a small business.
The disagreement rate is so high, in fact, that as many as 50% of business sale deals fall apart during these final stages of the transaction – way after both principals have already agreed on the business purchase price. And as for the few that happen to close the deal, it turns out that quite a number of the non-escrow transactions ultimately end up with the parties embroiled in legal disputes.
This article is the perfect guide if you’re looking to protect yourself from such unfortunate risks. It explains what business sale escrow entails, its purpose when you’re selling a business, where you could register an escrow account, plus the legal implications that come with it.
What is Business Sale Escrow?
As a business owner, you’ve probably experienced a fair share of basic transactions that involve escrow. If not, then at least you might have heard of the popular escrow payment solutions that come in to act as intermediaries between buyers and sellers.
There’s not much of a difference between those regular escrow systems and the business sale escrow. Just like the rest, business sale escrow is meant to act as a neutral account between business sellers and buyers where the transaction funds are temporarily held until all the conditions of the sale agreement have been met.
In essence, the business buyer deposits earnest money to the escrow as a show of good faith, and the service proceeds to facilitate a controlled ownership transfer of everything that comes with the business. It’s only after all the stipulated items have been exchanged that the funds are eventually released to the business seller.
Now, by “transfer,” we mean all the business assets and stock that have been negotiated in the purchase contract. This includes tangible items like real property, business equipment, and inventory, as well as intangible assets such as accounts receivable, intellectual property, plus licenses (liquor license, general business license, health permit, etc).
All in all, business sale escrow is flexible enough to fully cover whichever form of transfer you have in mind. You can set up an escrow agreement on an asset sale, a stock sale, or general mergers and acquisitions. It all depends on what you negotiate and agree on with the buyer.
More importantly, though, both parties need to agree on who to appoint as the escrow agent. The ideal candidate should be a third-party service provider who is not only duly licensed by the state to practice as an escrow intermediary, but who also happens to be experienced in administering business transfer processes.
Your business broker will, of course, help you in identifying a suitable agent based on the scope of the transaction. If you intend to transfer multiple assets, for instance, you’ll need an escrow officer who is capable of facilitating what we call bulk sales escrow.
In the meantime, you might want to be a little wary of your buyer’s agents who might try to double up as escrow officers.
Although their registered business broker - for instance - can proceed to legally hold the funds in a brokerage trust account, they may not be as neutral as escrow agents. Buyers and sellers are expected to engage their respective brokers individually for professional guidance while escrow agents should be serving as neutral parties until the transaction is concluded.
How the Escrow Process Works When Selling a Business
The business sale escrow process usually kicks off right when you’re about to close the deal, long after the business valuation and buyer prequalification stages.
By the time you engage an escrow company, both parties should have negotiated the sales agreement and agreed on not just the purchase price, but also the accompanying transfer terms - including the assets and stocks to be exchanged.
Once all the sales details have been ironed out between the business buyer and seller, they’re supposed to appoint an escrow holder.
While this could be one of the party’s attorneys, it’s often advisable to proceed with an independent escrow agent instead, so they can be trusted to remain unbiased between the two parties that are engaging in the business sale transaction.
That said, the terms for engagement are not uniform across the board. Rather, the seller, buyer, and escrow officer should enter into a custom escrow agreement. which ought to be based on the purchase agreement terms, plus their agreed transfer particulars.
All these escrow instructions are ultimately captured and documented by the escrow agent. Once the buyer and seller append their signatures on the agreement, an escrow account is opened to act as an independent holder of the business sale funds.
The buyer makes the first move by depositing money to demonstrate their commitment to the deal. To be specific, escrow services allow them to process their remittance via wire transfer, cashiers’ check, or loan transfer from a business purchase lender.
As for the amount, the standard rule is that it should be equivalent to the sale price stipulated in the business purchase contract. At least then, the seller can have peace of mind that the buyer indeed has the finances required for the deal, and intends to see it through to the end.
The buyer, on the other hand, gets the right to perform due diligence on the business. This procedure begins as soon as the business sale escrow is operational and should proceed until the close of the escrow.
In-between, you can expect the buyer to audit the entire business – particularly the assets, stock, and liabilities attached to the sale.
They will, for example, examine the accounts receivable and accounts payable, all the equipment used in the business operations, rental agreements, vehicles, real estate properties, plus the registered business licenses.
The point of all that is to confirm if the business and its assets indeed match what is described in the sale agreement. Your buyer will be looking to get exactly what they are paying for in the bulk sale. If there are any major red flags detected, the entire deal might fall apart.
And while the buyer proceeds with their inspection, the escrow company will conduct what is known as a Uniform Commercial Code (UCC) search on the business. This should identify any outstanding liens against the company or its assets.
Other than that, the bulk sales law requires the escrow agents to issue a Notice to Creditors of Bulk Sale. So, if you happen to have any outstanding debts, expect the creditors to file claims before the business sale transaction is concluded.
When all that is done, the escrow agent is expected to review everything and confirm if both principals have fulfilled their contractual obligations. They’ll refer to terms and requirements laid out in the purchase agreement – particularly on due diligence, as well as on the transfer of business stocks and assets.
If the business buyer and seller are found to have duly met their respective conditions, the business sale escrow will be closed and the funds transferred to the seller. But if the deal somehow turned sour and fell apart along the way, the money is returned to the buyer or lender.
Minus, of course, the escrow fees – which are typically split between the seller and the buyer.
The Benefits of Business Sale Escrow Services
When it comes to the whole process of selling businesses, escrow services have proven to be extremely helpful in the following ways:
#1. Acts as Security to Business Sale Transactions
As we’ve stated, it would be unwise to blindly commit yourself to a business sale transaction that is backed by nothing else but word of mouth.
A thorough pre-qualification process might help identify the most serious buyers all right, but it doesn’t offer any form of commitment guarantee. Never rule out the chances of the resultant prospects going back on their word, even after you’ve negotiated with them and agreed on the purchase terms.
That’s precisely what the business sale escrow service is built to prevent. By requiring prospects to deposit their purchase funds, it saves you all the trouble and frustration of dealing with potential busybodies.
Only a few buyers that demonstrate their commitment and good faith manage to proceed to the subsequent due diligence stage, where they get access to the most sensitive company information.
Channeling the funds through an independent third party also offers the surety that you won’t get from direct peer-to-peer payments. You see, once you’ve both fulfilled your obligations and the money is finally disbursed; the buyer won’t be able to meddle with your rightfully-earned payments.
Compare that with, say, direct checks, which remain cancellable mid-way through the clearing process.
#2. Ensures Fulfillment of the Contractual Obligations
The process of buying and selling a business is known to be lengthy and intricately complex, as it often involves balancing a wide range of technical parameters, financial computations, plus legal requirements.
As such, you might find it difficult to handle all your contractual and legal obligations while, at the same time, tracking the buyer’s corresponding progress. It’s even worse for solopreneurs who have no experience in business sale transactions.
Thankfully, business brokers can always help you reduce the load. But, if you’d like to tone it down even further, it’s always a good idea to supplement your business brokerage services with escrow.
The good thing about licensed escrow companies is they all have the legal authority to follow up on all the contractual obligations. The agents that you choose to engage are supposed to check and ensure that both principals have fulfilled their end of the bargain.
In a way, you could describe escrow as a contract enforcement body for business sale transactions. While business brokers guide you accordingly through the entire process, escrow agents will be checking in to confirm that the parties involved are meeting all their respective conditions for the sale agreement, due diligence, and funds transfer.
You don’t even have to follow up on what the business buyer is up to. The escrow company will be sure to look out for your interests by tracking everything.
The whole process is so strict, in fact, that the deal can only be closed once all the principals have satisfactorily carried out their contractual duties.
#3. Prevents Payment Disputes
Business sale transactions often involve the exchange of numerous items at varying rates. If you’re engaging in a bulk sale, for instance, chances are that you’ll be trading a vast array of assets, each at its own price.
Now, because of the many variables that come into play, such transactions are often marred by payment disputes – with business sellers and buyers exchanging all sorts of accusations.
Some buyers, for example, might complain that they didn’t receive what they paid for. Others may protest that the volume of physical assets doesn’t match up to what is documented.
As for sellers, on the other hand, their grievances would range from incomplete payments to sale price fluctuations and delayed remittances.
That being said, the chances of such a mess occurring on an escrow-administered transaction are very minimal. That’s because business sale escrow is designed to dynamically streamline the entire payment system in a manner that is convenient to both company sellers and buyers.
All the uncertainties and assumptions are replaced by a well-coordinated structure that holistically aligns all the fund transfers with the purchase agreements, contractual obligations, due diligence, plus the assets in question.
All in all, you could say that escrow serves not only as the record keeper, but also as the witness and the enforcer of all the payment procedures. Every single dollar is handled strictly by the book.
#4. Establishes a Legal Paper Trail
Speaking of record-keeping, you’ll also notice that escrow comes with a pretty neat system for documenting everything about the transactions, down to the finer details.
The record-keeping starts from the moment you engage an escrow agent, through the entire due diligence process, to the point the deal is finally closed. In addition to an escrow agreement that explicitly outlines the engagement terms, you’ll have records on the transfer of funds, plus information on what was exchanged between the seller and the buyer.
Also, it’s worth noting that all these documents are treated as a verifiable paper trail by legal entities. As long as your agent is duly licensed, even federal government agencies such as the IRS will duly uphold the escrow business transaction records.
That means they’ll be totally acceptable when you’re filing your tax returns. What’s more, the IRS is bound to refer to the documentation when auditing your capital gains from the entire business sales process.
Over to You - How to Work Your Way to a Truly Fulfilling Business Escrow
As we’ve established, the escrow process only comes in when you’re concluding the business sale transaction.
It is, by all means, a culmination of every single thing that you put into the whole process of selling the company – right from its preliminary business valuations, to the moment it first hits the market, through all the buyer prequalification procedures, purchase agreement negotiations, due diligence, all the way to the actual transition stage.
Whichever way you look at it, the outcome of your business transaction escrow depends greatly on how you choose to handle the entire sales process.
The early figures that you establish when valuing the company, for instance, will define the final sale price. The criteria that you use to qualify prospective buyers will go a long way toward determining the type of business buyer persona that you’ll be dealing with which also, in a way, will dictate their preferences, their evaluation of your business, plus, of course, the terms of engagement.
So don’t take anything for granted. Get yourself a reputable business broker like Beacon to walk with you through it all, and you’ll ultimately enjoy a seamless business sale transaction - complete with the sale price that your company truly deserves.
We can even start the math today. And no, it won’t cost you anything. Just get in touch with us, and our free valuation process will thoroughly examine your business across more than 150 data points. By the time we proceed to assist you with buyer prequalification, you’ll have figured out what your business is truly worth.
Explore your options
Get a 100% confidential and complimentary business valuation.
Davis Porter is an extensively published business author who, for over a decade now, has deeply specialized in B2B commerce, finance, digital marketing, and business tech. While he was always intrigued by the intricacies of entrepreneurship, it is his Business Management degree that ultimately sparked his burning fascination for examining and resolving incessant challenges in business/finance.
Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.