The Holdback Provision

Buyers of any business instinctively look for ways to mitigate their risk.  They may insist on an asset purchase vs. a stock sale to avoid inheriting potential corporate liabilities, when possible.  They may require a “tail” in the seller’s current liability insurance policy.  They will try to identify all likely liabilities for the future and address them in the Definitive/Purchase Agreement.

A common approach is to introduce a holdback provision, which has long been a practice in real estate, especially construction loans.  In essence, a small percentage of the sales proceeds are “held back” at closing to protect the buyer from unforeseen performance issues.  These funds, often 5 – 10% of the sales price, are held in an interest bearing account for a specified period of time, typically over a year.  If there are no issues the original funds plus interest are disbursed to the seller.  If issues arise, resolution is negotiated as specified in the Definitive/Purchase Agreement.

Sellers should be aware of these provisions and seek legal review if they appear.  While the language is typically focused on general liability issues, there may be specific financial performance standards for the company during the holdback period based on past performance.  If these benchmarks are not attained the holdback provision may permit the buyer to keep some of the held back funds.  Of course, this seems entirely reasonable to the buyer and less so to the seller, who may not be actively involved in company operations.