Angel Investors Network
    Glossary

    Escrow

    An arrangement where a neutral third party holds funds or assets until specific conditions are met, commonly used in M&A transactions and real estate deals.

    Escrow is a financial arrangement in which a neutral third party temporarily holds money, securities, or other assets on behalf of two parties until predetermined conditions in a transaction are satisfied. This mechanism protects both buyers and sellers by ensuring that neither party can access the funds or assets until all contractual obligations have been fulfilled, reducing transaction risk and building trust between parties who may not have an existing relationship.

    Why It Matters

    For angel investors, escrow arrangements provide critical protection during acquisitions and exits. When a startup you've invested in gets acquired, a portion of the purchase price—typically 10-20%—often goes into escrow for 12-18 months to cover any breaches of representations and warranties. This protects the buyer from undisclosed liabilities while ensuring sellers receive their full payment if no issues arise. Understanding escrow terms during negotiations can significantly impact your actual returns, as these held funds may represent a substantial portion of your exit proceeds.

    Example

    An angel investor holds 5% equity in a SaaS company acquired for $20 million. The purchase agreement stipulates that $3 million (15% of the purchase price) will be held in escrow for 18 months. The investor's share of the immediate payout is $850,000 (5% of $17 million), while $150,000 remains in escrow. During the escrow period, the buyer discovers that annual recurring revenue was overstated by $200,000, triggering an indemnification claim. After negotiations, $400,000 is released from escrow to the buyer, reducing the investor's final escrow distribution to $130,000. The total proceeds become $980,000 instead of the initial $1 million—a 2% reduction that could have been worse without the escrow cap negotiated in the purchase agreement.

    Understanding escrow connects to several other transaction concepts. Review Representations and Warranties to learn what conditions trigger escrow claims. Also explore Earnout provisions, which like escrow defer payment but based on future performance rather than past representations. Finally, examine Indemnification clauses that define how escrow funds can be claimed.