HOLDBACKS in Business Purchase Agreements
Pre-Acquisition - Letter of Intent - Due Diligence - Share Purchase / Sale - Asset Purchase / Sale - Merger - Equipment
Contact Neufeld Legal for business mergers and acquisitions at 403-400-4092 or Chris@NeufeldLegal.com
A holdback represents a specified portion of the total purchase price that the buyer withholds from the seller at the closing of the deal. Instead of being paid directly to the seller, this capital is temporarily set aside in a secure, third-party escrow account. The fundamental purpose of this arrangement is not to reduce the total agreed-upon valuation of the target business, but rather to create a source of security that protects the buyer against various post-closing uncertainties and financial exposures. It is a vital tool for risk allocation, providing the buyer with readily accessible funds to cover potential liabilities that may arise after the transaction is finalized.
The mechanics of a holdback are typically governed by precise terms outlined in the business purchase agreement. Once the deal closes, the holdback amount, which is often negotiated as a percentage of the total purchase price, commonly ranging from 5% to 20%, is deposited into an escrow account managed by a neutral agent, such as a bank or law firm. The funds remain locked in this account for a predefined duration (the holdback period), which can last anywhere from six months to two years, depending on the complexity of the business and the nature of the risks being mitigated. Upon the expiration of this period, provided no claims have been successfully made against the escrowed funds, the remaining balance is released to the seller.
The primary triggers for utilizing a holdback are associated with post-closing adjustments and indemnification claims. The most common use is to cover claims arising from breaches of the seller’s representations and warranties outlined in the business purchase agreement. For instance, if the seller guarantees the accuracy of financial statements and the buyer later discovers a material liability that was not disclosed, the buyer can make a claim against the holdback to compensate for their loss. Holdbacks are also frequently used to secure working capital adjustments, where a final calculation of the target company's working capital is made several weeks after closing, or to address specific performance obligations, such as the successful completion of a complex integration milestone or the resolution of pending litigation.
While holdbacks offer considerable protection to the buyer, they represent a key point of negotiation and risk for the seller. For the seller, the holdback amount is essentially delayed compensation, impacting their immediate cash flow and subjecting a portion of the sale proceeds to potential forfeiture. Consequently, sellers focus on minimizing the holdback amount, shortening the holdback period, and narrowly defining the specific circumstances under which the buyer can make a claim. Successful negotiation requires both parties to strike a careful balance, ensuring the holdback is sufficient to cover realistic risks without unduly penalizing the seller or undermining the overall value and feasibility of the transaction.
When it comes to the legal component of corporate mergers & acquisitions, that is when our law firm comes into play. Such that when your business is seeking knowledgeable and experienced legal representation in orchestrating and completing business mergers, acquisitions and divestitures, we are capable of providing such strategic legal advice and direction. Contact our law firm at Chris@NeufeldLegal.com or 403-400-4092 to schedule a confidential initial consultation for advancing your business' transactional objectives.