What Is Escrow? | Agency M&A Definition
Escrow is a financial arrangement where a portion of the purchase price is held by a neutral third party and released only when specific conditions are met or a defined period expires. In agency M&A, escrow protects the buyer against post-closing surprises such as undisclosed liabilities or breaches of the seller’s representations. It functions as a built-in insurance policy that keeps both sides honest after the deal closes.
Escrow in Agency M&A
Buyers evaluating a creative or digital agency typically insist on escrow because agency value is heavily relationship-driven and difficult to verify completely before closing. A buyer might discover after the sale that a key client was already planning to leave, that reported revenue included inflated retainer values, or that a freelancer was misclassified as an employee — creating tax liability. The escrow account provides a pool of funds to cover these scenarios without requiring the seller to write a personal check months after walking away from the business. In agency transactions, escrow amounts generally range from 10-20% of the total purchase price and are held for 12-24 months. The escrow agent — usually a bank or law firm’s trust department — follows release instructions outlined in the purchase agreement. For smaller agency deals under $2 million, some buyers accept a holdback arrangement instead of formal escrow, where the buyer simply retains a portion of the price rather than involving a third-party custodian. The costs of establishing and maintaining the escrow account, typically $2,000-$5,000 annually, are usually split between buyer and seller.
How Escrow Affects Agency Valuation
Escrow does not change the total purchase price, but it meaningfully affects the seller’s cash flow and risk profile. A seller receiving $2.5 million with 15% in escrow gets only $2.125 million at closing and must wait 12-18 months for the remaining $375,000 — assuming no claims are made. From a time-value-of-money perspective, that deferred payment is worth less than cash at closing. Sellers can negotiate to reduce escrow impact by pushing for shorter hold periods, lower escrow percentages, or scheduled partial releases where half the escrow is freed at six months if no claims exist. In competitive bidding situations with multiple buyers, a lower escrow requirement can make a nominally lower offer more attractive to the seller in real terms.
Example
An SEO and content marketing agency sells for $1.8 million. The buyer requires a 15% escrow, so $270,000 is deposited with a third-party escrow agent at closing, while the seller receives $1.53 million. The escrow agreement specifies an 18-month hold period. At month 8, the buyer discovers that the agency underreported $40,000 in outstanding freelancer payments. The buyer files a claim against the escrow, and after a 30-day resolution window, $40,000 is released to the buyer. At month 18, the remaining $230,000 is released to the seller. Had the seller negotiated a 10% escrow instead, only $180,000 would have been at risk, and they would have received $1.62 million at closing — $90,000 more in immediate liquidity.
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