Escrow and holdbacks, explained

A purchase agreement makes the seller responsible for problems that surface after closing but existed, undiscovered, before it — an unrecorded liability, a misstated financial figure, a representation that turns out not to have been true. The right to be compensated for that is only as good as the seller’s ability to actually pay when a claim is made, and by the time a problem surfaces, the seller has usually already spent some or all of the proceeds. An escrow or holdback solves that problem directly, by keeping a defined amount of money set aside and available specifically to fund a valid claim, rather than leaving the buyer to chase a seller who may no longer have the funds.

Escrow and holdback are not quite the same thing

The two terms get used almost interchangeably in casual conversation, but they describe slightly different mechanics. An escrow involves a neutral third party, typically a lawyer or a dedicated escrow agent, who holds the funds under a separate escrow agreement and releases them only according to instructions both sides agreed to in advance. A holdback, by contrast, is often simply the buyer retaining part of the price directly, without a third party involved, governed entirely by the terms written into the purchase agreement itself. Sellers generally prefer a true escrow with an independent agent, since it removes the buyer’s unilateral control over the money; buyers sometimes prefer a direct holdback for the same reason, in reverse. Which structure a specific deal actually uses is itself a negotiated point, not a fixed convention.

What the money is actually there to cover

Most escrows and holdbacks are tied specifically to the indemnification provisions in the purchase agreement — they exist to fund a claim if a representation or warranty turns out to have been false, or if a specific, identified risk from due diligence materializes after closing. This is a distinct mechanism from a working capital true-up, which adjusts the price based on a neutral accounting calculation rather than a claim of breach, though both sometimes draw from the same pool of funds set aside at closing. Knowing which category a specific claim actually falls under matters, because each is typically governed by its own process, deadline and standard of proof within the agreement.

How big the amount is, and how that number gets set

The size of an escrow or holdback is negotiated in relation to the indemnity cap — the overall ceiling on how much a seller can be required to pay out for breaches — and in relation to the specific risks diligence actually identified. A buyer who found a real concern during diligence will typically push for a larger holdback tied specifically to that risk; a seller confident in a clean diligence process will push back on an oversized holdback that effectively just reduces the cash they receive at closing for no identified reason. There is no standard proportion that applies to every deal, whatever a general industry conversation might suggest — the right size follows from what the specific diligence process actually turned up.

How long the money stays locked up

An escrow or holdback is released according to a schedule tied to the survival period of the representations it secures — once that period passes without a valid claim being made, the funds, or whatever remains after any claims, are released to the seller. Different categories of representations often carry different survival periods, and a holdback tied to a longer-surviving category will naturally stay locked up longer than one tied only to general operational representations. Sellers should confirm, before signing, exactly what triggers release and whether partial release happens at intervals rather than only at the very end of the period.

How a claim against it actually gets made

The purchase agreement sets out a specific process for a buyer to make a claim against escrowed or held-back funds — typically a written notice describing the claimed breach and the amount sought, delivered within an agreed window, with the seller given an opportunity to dispute it before funds are released. Where the two sides disagree about whether a claim is valid, the agreement usually specifies how that disagreement gets resolved, whether through negotiation, an independent expert, or arbitration, rather than leaving it to default to litigation. A vague or missing claims process is one of the more preventable weaknesses in a purchase agreement, since it is exactly the mechanism both sides will need to rely on if anything ever actually goes wrong.

What commonly goes wrong

The most frequent problem is an escrow or holdback provision drafted loosely enough that both sides can plausibly interpret it in their own favour once an actual claim arises — an ambiguous trigger for release, an undefined process for disputing a claim, or a size set without reference to the indemnity cap it is supposed to secure. A second common issue is a holdback that was never properly funded or documented as a separate account, leaving the seller uncertain whether the money is actually segregated or simply commingled with the buyer’s own operating funds. Both problems are entirely preventable with careful drafting at signing, and both become expensive, adversarial arguments if left to be sorted out only once a real claim is on the table.