Why Business Sales Fall Apart in Escrow

What escrow is in a business sale

Escrow is a period in which a neutral third party, an escrow company or an attorney, holds the buyer's money and the signed documents until every condition in the contract has been met. When they are, the money is released to you, and ownership passes to the buyer. If a condition is not met, the closing waits, or the contract ends.

Those conditions are the part to understand. The purchase agreement lists things that must be true before the buyer has to close. The landlord must consent to the lease. The lender must fund the loan. Licenses and permits must move over, or be reissued. Certain contracts must be assigned. The buyer's last review of the business must not turn up anything serious. The employees and key customers should still be in place. Your side has its own list, which usually includes proof that taxes and debts are paid. Rules for how escrow works and what the parties must do vary by state, and your attorney confirms what applies to your sale.

The period often lasts a month or two, though it can run longer when a lender or a license is slow. Our post on the closing describes the sequence in more detail. The point here is that a deal in escrow has many moving parts, and each one is a place for delay.

The landlord holds a key you do not control

The lease is the most common obstacle. In most business sales, the buyer takes over your lease, and the landlord has to agree. Landlords have no deadline of their own. They may ask for a new deposit, a personal guarantee from the buyer, a higher rent, or financial statements from a buyer they have never met. Some take weeks to answer a letter. Some use the moment to renegotiate terms they have wanted to change for years.

A lender will want a certain amount of time remaining on the lease, and if you have only a short term left, the landlord's extension becomes a condition for the loan. A buyer who sees the lease is in doubt may start to reconsider the whole deal. Our post on the lease as part of the deal describes how to approach this early.

What you can do: read your lease before you list, find out what the assignment clause requires, and have an honest talk with the landlord about renewal while the sale is still quiet. Once the buyer is chosen, introduce them and let the landlord ask questions. A landlord who feels informed answers faster than one who feels hurried.

The lender changes its mind

Many buyers of small companies borrow part of the price, often through an SBA loan, and the lender is a participant in the closing whether you meet them or not. The lender reviews the same financials you gave the buyer, plus the buyer's credit and the lease. They may order an appraisal of the equipment or the building. They can ask for more documents in the last week.

Lenders sometimes see the numbers differently from the buyer. An add-back that the buyer accepted may be disallowed. A decline in the most recent months may cause the lender to ask for a lower loan amount. A customer concentration the buyer was comfortable with may concern the underwriter. When the loan shrinks, the buyer must find the difference elsewhere. They can ask you to carry more of the price in a note, ask for a lower price, or leave.

You can reduce this risk by sending the lender clean, consistent records and by answering requests fast. Our post on SBA loans in business acquisitions explains what lenders look for. Ask early whether the buyer has a commitment letter or only a pre-approval, since one is far firmer than the other.

The numbers move after you signed

Between signing and closing, the buyer usually completes a deeper review of the books and operations. If your financial statements were not in order when you went to market, this is where it shows. A bank statement that does not match a deposit schedule. Revenue booked in a different month than the tax return. An expense that a buyer cannot trace. Each one is small, and together they teach the buyer to doubt the rest.

A buyer who finds a problem has a few choices, and none is good for you. They can ask for a price reduction. They can ask for a larger holdback. They can request a payment that depends on future results, which shifts risk to you. They can also leave, if the contract allows. Our post on quality of earnings reports describes how having your numbers reviewed before the sale removes most of these surprises. Our post on getting your financials ready does the same.

If the review does find an error, say so quickly and calmly. Credit the buyer for a mistake that is genuine and push back when the claim is exaggerated. Buyers who feel they were told the truth tend to settle fair adjustments. Buyers who feel they uncovered a hidden problem tend to ask for a great deal more.

The business changes while you wait

A business keeps moving during escrow, and a buyer is watching. If sales dip for two months, the buyer may want a lower price. If a key employee quits, a customer complains, or a supplier raises terms, the buyer will count it. Some owners ease off once the contract is signed, because they feel the work is finished. Most would do better to run the company harder than ever until the closing, since the buyer pays for the results they see, and the contract usually allows them to adjust for a material decline.

Keep the business ordinary. Do not take on new debt, change pricing sharply, sign long contracts, pay yourself unusual amounts or let inventory run down. The purchase agreement typically restricts these steps, and some of them affect the working capital the buyer expects to receive. Our post on earnouts, holdbacks and working capital explains why the working capital figure is a common dispute at the end.

Confidentiality matters in this period too. Employees and customers may hear of the sale as the lender, landlord and attorneys ask questions. Decide in advance who you will tell and when. Our post on telling your employees can help you plan, because a surprise at this stage can cause the very departures a buyer is worried about.

Second thoughts and late requests

Some deals fail because the buyer simply gets nervous. The purchase is large, the buyer may have borrowed against their home, and the closing is near. Spouses, partners and advisors who were not part of the earlier talks may ask hard questions late. A buyer who has had time to think can find reasons to doubt the decision.

Others fail because a buyer uses the period to ask for more. A few weeks before the closing, a new request arrives: a longer non-compete, a larger holdback, a different employment arrangement for you, a price adjustment for an item that was disclosed from the start. Buyers know that you are tired and that your alternatives have gone away. The best defense is to have a backup buyer, even quietly, and to have your advisor and attorney review each request against the contract before you answer. A request that is reasonable can be agreed to. One that rewrites the deal can be refused, and you should know what you would do if the buyer walks.

Look for signs of trouble early. A buyer who has stopped returning calls, who misses deadlines on their side, or who raises new topics each week may be losing interest or struggling to fund the purchase. Ask directly what is going on. Silence from the other side during a closing is information.

Keeping it together

A sale that closes has a few habits in common. Someone owns the checklist and checks it every week: the lease consent, the loan, each contract assignment, the permits, the payoff letters for your debts, the insurance, the final accounting. The owner returns calls and documents quickly. The books were clean before the contract, so nothing new surfaced. The landlord and key vendors were approached early. The business ran well through to the end. A backup is available in case the buyer cannot finish.

Business Advisors of America works through escrow with owners week by week, because that is where most of the risk lives and where a calm, organized seller makes the largest difference. If you are heading toward a sale, the work that protects your closing starts well before the contract. Fix the lease, tidy the books, tell the truth about your numbers, and expect that the last stretch will ask more of you than the first.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.