Guide
Escrow, holdbacks and indemnities
Diligence finds things. What you do next is either reprice the deal or arrange for the risk to be carried by someone — and most of the time it should be both, in different proportions, for different findings.
On this page8 sections
Three different things, routinely confused
| What it is | What it is worth | Main weakness | |
|---|---|---|---|
| Indemnity | A contractual promise by the seller to make you whole for a defined loss | Exactly as much as the seller's ability and willingness to pay when called | Unfunded. You are a creditor with a claim, not a holder of money |
| Holdback | Purchase price you do not pay at closing, released later | Real, to the extent you control it | If you hold it yourself, disputes over release get personal quickly |
| Escrow | A holdback placed with a third party under agreed release terms | Real, and neutral | Costs something, and the release mechanics have to be drafted properly |
| Note offset | A right to reduce what you owe on a seller note | Depends entirely on the note's terms and your financing | On a standby note the payment stream may be years away [2] |
The pattern to notice: each row down the table is harder for the seller to accept and better for you. That is the negotiation, and knowing which one you are actually being offered is most of the work.
Start with who the seller will be afterwards
This is the question that determines everything else, and it is the one least often asked at the table.
An indemnity is a right against a person or an entity. So ask, concretely: in two years, who is that, and what do they have? Most New York small businesses are sold by someone retiring. The proceeds are distributed. The selling entity may be dissolved. The individual has moved, retired, and spent a meaningful part of the money.
An unfunded indemnity from a retiring seller is not a protection, it is a hope. This is not a comment on the seller's honesty — most sellers intend to honour what they sign. It is about what remains reachable. If a finding matters enough to require an indemnity, it matters enough to require something behind it. And if the seller will not put anything behind it, that itself is information about how confident they are.
Sizing it from the findings, not from a rule of thumb
Percentages get quoted in this area, and they are the wrong starting point — not because a percentage is always wrong, but because a number you cannot explain loses to a number the other side can argue with.
Work from your diligence findings instead. For each one, three questions:
- What is the plausible worst case, in money? Not the expected case — the case you are protecting against.
- When would it surface? This sets the release date, and different exposures have genuinely different clocks.
- Would you know about it, and could you prove the seller caused it? An exposure that is hard to attribute needs a different mechanism from one that is unambiguous.
| Exposure | Why it needs cover | Timing to think about |
|---|---|---|
| Unpaid sales tax | Purchaser liability follows the business under the bulk-sale rules [1] | Runs until the relevant assessment position is resolved. File the notice as well — the holdback is not a substitute for it |
| Other tax exposure | Payroll, income, and any position taken on an unusual item | Follow the assessment periods, not the deal calendar |
| Environmental | Liability attaches to the owner of the property [3] | Often the longest of any exposure. See environmental diligence |
| Receivables | The balance sheet says collectible; ageing may disagree | Short — a collection cycle or two tells you |
| Litigation and claims | Known matters, and unknown ones arising from pre-closing conduct | Known matters can be escrowed specifically at their own number |
| Employment | Accrued entitlements, classification questions, unpaid wage exposure | Usually surfaces within the first year |
| Licences and permits | A transfer that fails, or a condition discovered late | Tie release to the approval actually being received |
| Customer and contract | Whether the revenue you underwrote actually renews | One full renewal cycle. On an SBA deal, note the earnout prohibition below |
The mechanics worth getting right
Most disputes about a holdback are not about whether the risk was real. They are about the release process, which is why the drafting matters more than the number.
- Who holds it. A neutral escrow agent removes the worst dynamic — a buyer sitting on money the seller believes is theirs.
- What triggers a claim, and by when it must be notified. Vague triggers produce arguments at exactly the moment you least want one.
- What happens on a disputed claim. Does the money stay put until resolved? Silence here is a gap that favours whoever is more willing to escalate.
- Staged release. Different exposures, different dates. Releasing a receivables holdback at six months while environmental cover runs longer is more sellable than one long date over everything.
- Survival periods, caps and baskets. How long the representations live, the maximum recoverable, and the threshold below which claims cannot be brought. Carve out anything diligence already identified — a known exposure should not be absorbed by a basket designed for surprises.
- Interest. Who earns it on escrowed funds. Small, and worth settling rather than leaving.
- Specific indemnities for specific findings. Where diligence found a defined problem, cover it by name at its own number rather than folding it into general representations.
What SBA financing permits
If you are borrowing, the structure is constrained before you begin negotiating, and knowing the constraints early stops you agreeing to something that later has to be unwound.
- Seller earnouts are prohibited on an SBA change of ownership. Only a buyer rebate is permitted, and its proceeds must be applied to loan principal [2] . So the common proposal — "pay me more if the customers stay" — is off the table, and the inversion is what works. See the earnout guide.
- A seller note on full standby requires no payments of principal or interest for the term of the 7(a) loan, and can fund no more than half of the required equity injection [2] . That matters here because a right of offset against a note with no near-term payments behaves differently from one against a note being paid monthly.
- The seller cannot remain as an officer, director, stockholder or employee, and a consultancy is capped at 24 months [2] . So structures that rely on the seller's continued involvement to manage a risk are not available to you.
Take the intended structure to your lender early. A holdback or escrow that has not been discussed with the lender can hold up a closing at the worst possible moment.
Or reprice instead
A holdback is not always the right answer. Sometimes the cleaner response to a diligence finding is a lower price — you take the risk knowingly, priced, and nobody is arguing about release conditions in eighteen months.
| Reprice when… | Hold back or escrow when… |
|---|---|
| The finding is certain — a cost you now know you will incur | The finding is contingent — it may cost nothing, or a great deal |
| It is quantifiable now | The number depends on something not yet known |
| It is ongoing and structural — it changes the earnings you underwrote | It is a one-off exposure from the seller's period of ownership |
| You want a clean break with no post-closing entanglement | The exposure is large enough that you need money reserved against it |
Where the finding changes what the business earns rather than creating a discrete risk, price is usually the honest instrument — and it is the subject of the retrading guide.
Raise the principle at the letter of intent
The single most useful timing decision here is to put the principle into the letter of intent before diligence begins: that findings may be addressed through price adjustment, holdback, escrow or specific indemnity.
You are not naming a number — you do not know one yet. You are establishing that this is a normal part of the process rather than something introduced late. A seller who has agreed to the principle at the LOI stage reacts very differently to a holdback proposal in week six than one hearing about the concept for the first time.
A necessary limit
This page explains what these mechanisms are, what they are worth, and how to size them from your own findings. Drafting them is legal work, and the difference between a holdback that functions and one that produces a dispute is almost entirely in the drafting.
Take your diligence findings and your intended structure to counsel, and to your lender if you are financing. What this page should give you is the ability to arrive at both conversations knowing what you are asking for and why.
Frequently asked questions
What is the difference between an escrow, a holdback and an indemnity?
An indemnity is a promise: the seller agrees to make you whole if a defined thing goes wrong. A holdback is money you do not pay at closing, so the promise has something behind it. An escrow is a holdback placed with a third party under agreed release terms, so neither side controls it. They stack — an indemnity with nothing behind it is only as good as the seller's willingness and ability to pay it two years from now.
Why does it matter who the seller is after closing?
Because that is who you would have to pursue. Most New York small businesses are sold by someone retiring, and the entity may be wound up while the proceeds are distributed and spent. An indemnity from a person who has retired and dispersed the money is a legal right against a diminishing target. That is the whole argument for holding something back rather than relying on the promise alone.
How much should be held back?
It should be reasoned from the exposures your diligence actually found, not taken from a rule of thumb. Work out what could plausibly come back at you — unpaid sales tax, an environmental finding, a disputed receivable, a licence problem — put a number and a likely timing on each, and size the holdback against that. A figure derived from identified risks is also far easier to defend across the table than a percentage you cannot explain.
How long should a holdback last?
Long enough for the risk to surface, which means the period should follow the exposure rather than a default. A tax exposure runs until the relevant assessment period closes; a customer or contract risk usually shows up within a renewal cycle; an environmental issue may take longer than either. Different exposures can have different release dates, and often should.
Can I use an earnout instead?
Not on an SBA-financed change of ownership. Seller earnouts are prohibited. What is permitted is a buyer rebate — the inversion of an earnout, with proceeds applied to loan principal rather than paid to you. If a seller proposes a retention-based earnout, that is the moment to say the financing does not allow it and move to a structure that does.
What about offsetting against the seller note?
It is the mechanism buyers most often reach for, because on many deals the seller note is the only money still in reach after closing. It is also the one that most needs to be checked against your financing before you rely on it: where a note is on full standby, no payments of principal or interest are made for the term of the 7(a) loan, which changes what an offset right practically does. Raise it with counsel and confirm the mechanics with your lender rather than assuming.
What is a basket, and should I agree to one?
A basket is a threshold — claims below it cannot be brought, so small items do not generate disputes. It is reasonable in principle, and the detail decides whether it is reasonable in practice: whether it is a true deductible or tips from the first dollar once crossed, and whether specific known exposures are carved out of it. Anything your diligence has already identified should generally sit outside the basket.
Sources cited on this page
Every mutable number on this page — program caps, tax rules, thresholds, filing deadlines — traces to one of these primary sources. Rules change; check the source before you act on the number.
- 1 NYS Department of Taxation and Finance. Tax Bulletin ST-360: Purchasers' Obligations to Pay Sales Taxes (Bulk Sales). https://www.tax.ny.gov/pubs_and_bulls/tg_bulletins/st/purchasers_obligations_to_pay_sales_taxes.htm
- 2 U.S. Small Business Administration. SOP 50 10 8.1 — Appendix 15: 7(a) Changes of Ownership. https://www.sba.gov/document/sop-50-10-lender-development-company-loan-programs
- 3 U.S. Environmental Protection Agency. All Appropriate Inquiries. https://www.epa.gov/brownfields/all-appropriate-inquiries
Educational only — not legal, tax, lending, or investment advice. Confirm specific rules, rates, and forms with the relevant New York State agency, attorney, CPA, lender, or insurer before acting. See the editorial policy and methodology for how sourcing and review work.