Escrow of shares: Overview, definition, and example
What is escrow of shares?
Escrow of shares refers to the practice of placing shares of stock in a third-party escrow account, where they are held temporarily until certain conditions or terms outlined in an agreement are met. The third party, called the escrow agent, is responsible for safeguarding the shares and ensuring they are only released to the appropriate party once the specified conditions have been fulfilled. This arrangement is commonly used in mergers and acquisitions, shareholder agreements, or financing arrangements to protect both parties and ensure that the conditions of the agreement are met before the shares change hands or are fully transferred.
For example, in a merger agreement, shares of the acquiring company might be placed in escrow until the target company meets specific performance milestones.
Why is escrow of shares important?
Escrow of shares is important because it provides security and protection to both parties in a transaction. It ensures that the agreed-upon conditions, such as regulatory approvals, financial targets, or other milestones, are satisfied before the shares are fully transferred or used. For buyers, it ensures that they do not lose their investment before the conditions are met. For sellers or other parties, it guarantees that the shares will be released as promised once the terms are fulfilled.
For businesses, using an escrow account for shares can be an effective way to mitigate risk, provide assurances to both parties, and ensure compliance with contractual obligations. It is often used to address concerns over potential performance failures or to protect one party’s interests in case of a breach.
Understanding escrow of shares through an example
Imagine a company, XYZ Corp., is acquiring a smaller company, ABC Ltd. As part of the agreement, XYZ Corp. will issue 1 million shares to the shareholders of ABC Ltd. However, some of the shares are placed in escrow for a period of 12 months to ensure that ABC Ltd. meets certain revenue targets post-acquisition. If the revenue targets are met, the shares are released from escrow and transferred to the shareholders of ABC Ltd. If the targets are not met, the shares may be returned to XYZ Corp. or other corrective actions may be taken as outlined in the agreement.
In another example, an investor may provide financing to a startup in exchange for shares in the company. To ensure the investor's protection, the shares are placed in escrow until the startup achieves certain milestones, such as reaching a specific revenue threshold or securing additional funding. Once the conditions are met, the shares are released to the investor.
An example of an escrow of shares clause
Here’s how an escrow of shares clause might appear in an agreement:
“The Shares to be issued by the Buyer to the Seller under this Agreement shall be placed in escrow with [Escrow Agent] for a period of [insert period] from the Closing Date. The Escrow Agent shall release the Shares to the Seller upon confirmation that the conditions set forth in Section [insert section] have been met, including the achievement of the following performance targets: [insert targets]. If the conditions are not met within the specified period, the Shares shall be returned to the Buyer.”
Conclusion
Escrow of shares is an essential tool in many business transactions, particularly in mergers, acquisitions, and financing arrangements. By placing shares in escrow, parties can ensure that the terms of the agreement are met before the shares are fully transferred or utilized, providing protection and assurances to both parties. Whether used to safeguard performance targets, ensure compliance with milestones, or protect investments, the escrow of shares helps mitigate risk and build trust in complex transactions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.