What is a Holdback in a Merger and Acquisition Transaction?
In merger and acquisition transactions, a holdback is a portion of the purchase price that a buyer may, with the vendor’s consent, withhold at a closing for a variety of reasons. The funds are to be released later if certain conditions and/or timeframes are fulfilled.
Holdbacks serve as insurance. The idea behind is it that, despite conducting all due diligence and receiving certain representations and warranties from the seller, there is always a residual risk of potential uncertainties. These can include unknown debts, breaches of warranties and representations, and other undisclosed issues or post-closing adjustments. A holdback provides the buyer with some funds to off-set the surprises without having to pursue the seller, and avoiding costly and time consuming litigation, for reimbursement.
Why Holdbacks are Useful:
For Buyers
- Protection Against Unknown Risk: If the seller’s warranties turn out to be inaccurate or a pre-closing liability surfaces post-closing, the buyer can use the holdback funds to cover loss.
- Leverage for Post-Closing Cooperation: If the deal involves transition support or other post-closing obligations, a holdback helps ensure the seller honours their obligations.
- Avoids Costly Litigation: With funds already held in escrow, disputes can often be resolved more efficiently and thereby avoiding enforcement costs.
For Sellers
- Easier to Close the Deal: Being open to a holdback can make the seller more attractive to buyers.
- Defined Risk: A holdback can sometimes set a clear cap on the portion of the purchase price at risk.
- Confidence Signal: Agreeing to a holdback shows that the seller believes in the integrity of their business and their disclosures.
Why Wording is Everything:
The strength of a holdback depends on how it is written into an agreement of purchase and sale, for a poorly drafted holdback agreement weakens its effectiveness.
When drafting a holdback agreement, the draft needs to consider the following:
- Release Conditions
Clearly define when the holdback is to be released. It could be time-based (i.e. 12 months post-closing) or event-driven (i.e. delivery of audited financials). Vague language like “upon satisfactory performance” invites disputes.
- Partial Releases
Consider a staggered release structure. For example, half the holdback after 6 months, the rest after 12 months – especially when risks decrease over time or are tied to performance milestones.
- Dispute Resolution
The agreement should explain what happens if there is a disagreement over releasing funds. Will a third party decide? Is arbitration required? Include notice periods, response windows, and what evidence is needed to withhold payment.
- Escrow Mechanics
Funds are usually held back by either the buyer’s lawyer or the seller’s lawyer in trust. The agreement must instruct the lawyer with precise terms for what is needed to release or return funds, including documentation, timing, and mutual or unilateral sign-off.
- Indemnification & Limitations
Make sure the holdback aligns with the broader indemnification provisions.
Best Practices for Using Holdbacks
- Tailor the size to the risk
- Use objective triggers (i.e. milestones)
- Align the undertaking to holdback funds with the purchase agreement
- Avoid open-ended timelines
- Consult legal and tax advisors
Conclusion:
Holdbacks are a powerful risk-management tool in merger and acquisition transactions, but only if structured and worded with care. For buyers, they offer a layer of protection. For sellers, they demonstrate transparency and accountability. In the end, it’s not just the concept of a holdback that matters – it’s the details in the drafting that determines whether it protects or complicates the deal.
Contact us today to schedule a consultation and let us help you navigate the complexities of buying a business through an asset purchase. Your success is our priority.
