Holdback vs Escrow: Who Is Holding the Retained Money

A holdback and an escrow both keep part of the price back. Under an escrow the buyer pays the money to a third party who holds it on terms both sides signed. Under a holdback the buyer simply does not pay it. The rupees are identical here, Rs 113.70 crore, and custody decides which side has to act to move them.

Everything below rests on one number and one split. Harivansh Packaging Limited, an invented listed buyer of packaging, paid the sellers of Sundarban Polymers Private Limited, an invented maker of films, a price of Rs 1,137 crore, and that figure is the adjusted equity valueThe price after the last measurements taken at closing have been run through it. The sellers were paid this adjusted figure rather than the rounder number that went out in the announcement. of the transaction, arrived at after two measurements at closing moved the earlier Rs 1,140 crore by a net Rs 3 crore. How that Rs 1,137 crore was built, and why the earlier figure is the wrong thing to strike anything on, is worked through separately. Here it is simply the base, and nothing below is struck on any other figure.

The split is a tenth. Rs 1,137 crore leaves Harivansh Packaging as two amounts rather than one. Nine tenths of it, Rs 1,023.30 crore, goes across on the day. The remaining tenth, Rs 113.70 crore, stays behind for eighteen months. Nine tenths and one tenth is the entire arithmetic here.

Two other things are settled elsewhere. A ceiling on liability is a promise and money in an account is money, and the difference between the two is worked separately. The sellers of Sundarban Polymers are private holders who are paid at completionThe day the deal actually happens: the shares change hands, the money moves, and the two businesses stop being separate. Almost everything a transaction document does is timed from it. and then have no continuing role in the business, so once they walk out of the room the only thing connecting them to Harivansh Packaging is that retained tenth. Custody is therefore the whole question: for eighteen months, a group of people who no longer run anything are waiting on a sum of money, and where it is sitting decides how comfortable that wait is.

What is a holdback, and what is an escrow?

A holdback and an escrow are almost always introduced together and almost never defined apart. Take them one at a time.

A holdback is part of a price the buyer does not pay yet. There is nothing more to it than that. The document says the price is Rs 1,137 crore, the document says Rs 113.70 crore of it is retained for eighteen months, and on the day of completion Harivansh Packaging transfers Rs 1,023.30 crore and keeps the rest in its own accounts. No third person is involved. No separate account exists. The retained tenth is not sitting anywhere special; it is mixed in with all the other money Harivansh Packaging has, being used for whatever Harivansh Packaging uses money for. The sellers have a line in a document saying they are owed it.

An escrow is part of a price the buyer does pay, but not to the sellers. On the day of completion Harivansh Packaging transfers Rs 1,023.30 crore to the sellers and Rs 113.70 crore to a third party who has agreed, in writing, to hold that money and to release it only on stated terms. Both sides sign that arrangement before completion. The money has genuinely left Harivansh Packaging. The sellers do not have it either. The retained tenth is parked somewhere neither side can reach into.

The everyday version is the same arrangement at a scale anyone can feel, so it is worth taking seriously. A householder agrees Rs 40,000/- with a contractor to redo a bathroom. The work looks finished, but nobody knows yet whether the waterproofing holds, and that takes a monsoon to discover. So the householder pays Rs 35,000/- and keeps Rs 5,000/- back until the rains have been through. The Rs 5,000/- kept back is a holdback. The money sits in the householder's bank account and can be spent. The contractor has to come back and ask for it, and the householder decides, at that moment, whether to pay.

Now change one thing and nothing else. The householder and the contractor walk down together to a shopkeeper they both trust, hand him Rs 5,000/- between them, and write out a note he keeps: he releases the money thirty days after the last rain if there has been no complaint, and if there is a complaint he waits until the two of them have settled it. Neither of them can take the money back from him. The shopkeeper's note is an escrow. Same Rs 5,000/-, same wait, same job, and a completely different position for both of them.

The rupees can be identical and the arrangements are not, and every difference that follows comes from one question: whose hands is the money in while everyone waits? Whose hands the money is in carries most of what follows.

Why does it matter who is physically holding the money?

Because money in one's own hands and money in somebody else's hands are the same amount and a completely different position, and the difference is not about trust. The difference is about effort.

Getting a sum of money out of three different places takes sharply different amounts of work. Out of one's own current account: nothing. The money is already there. Out of a stranger's account, where the stranger has agreed in advance in writing exactly when to let it go: the wait runs to the stated moment and the stranger acts. Out of somebody else's account, where that somebody would rather keep it and has no written instruction telling them when not to: the money has to be asked for, and if the answer is no, something has to be done about it.

The three situations describe, in order, Harivansh Packaging under a holdback, both sides under an escrow, and the sellers under a holdback. Nothing about the size of the money changes across them. The one thing that changes is who has to spend energy.

Here is the test, and it needs no legal knowledge at all: ask who has to do something for the money to move. The side that can get its preferred outcome by doing nothing is the side in the comfortable position. Doing nothing is free. Doing something costs time, attention, adviser fees, and eventually a willingness to fall out with somebody. In any arrangement where two parties disagree about money, the party that wins by default has an advantage that never appears as a number anywhere in the document.

Custody is therefore not a technicality, and not a detail about plumbing between bank accounts. Custody decides, in advance and permanently, which of the two parties is going to be the one making phone calls in month nineteen. The document that creates a holdback has quietly appointed the seller to that role. The document that creates an escrow wrote down what happens instead, so it has appointed nobody.

Which side has to act, under each?

Run the same moment through both arrangements. The date is month eighteen. The retention period is up. Nobody has raised anything, nobody has written anything, and neither side has done a single thing.

Under an escrow, the terms both sides agreed before completion are now running. The stated date has arrived, the stated conditions either have or have not been met, and the third party holding the money does what the arrangement told it to do. Neither Harivansh Packaging nor the sellers has to persuade anybody. The document is doing the work it was written for.

Under a holdback, nothing happens. Absolutely nothing. The money is in Harivansh Packaging's accounts, where it has been for eighteen months, and there is no mechanism anywhere that moves it out. The sellers have to notice the date, write to Harivansh Packaging, and ask. Harivansh Packaging then decides what to do about that request, and if it wishes to raise something first, it is raising it while holding the cash.

The difference is not one of fairness, and reading it as one sends somebody looking for a villain who is not there. Neither arrangement is generous and neither is a trick. Both were negotiated between two sides with advisers. The two arrangements differ in who bears the friction if there is ever a disagreement, and friction is a real cost even when everybody behaves impeccably. A seller under a holdback who is owed money by a buyer with no grievance at all still has to write the letter, chase the reply, and wait on somebody else's decision cycle. A seller under an escrow, in the same blameless situation, waits for a date.

Notice also what a holdback does to a disagreement that is genuinely close. Suppose there is a real argument, on which reasonable people could land either way. Under a holdback, the party that gets to keep doing nothing while the argument runs is the party holding Rs 113.70 crore. Under an escrow, the money is with somebody who is not arguing, so the argument runs on its own merits rather than against a clock that is quietly favouring one side.

What does each arrangement do to the seller's position?

Start with what is identical. The identical part is larger than people expect. Under both arrangements the sellers are short Rs 113.70 crore for eighteen months. Under both, that money is unavailable to them: they cannot spend it, cannot lend it, cannot put it into the next thing they want to do. Under both, they have already handed over the business and cannot undo that. Whatever a seller feels about a retention, the feeling is the same size in both cases, and any argument that treats one of them as materially less painful in cash terms has miscounted.

The difference is not the size of the gap in the seller's pocket but the quality of what fills it. Under an escrow the sellers have a visible, identified, ring-fenced sum sitting somewhere they can name, held by somebody who is not on either side, coming out on terms they read and signed before they agreed to anything. Under a holdback they have a claim against a company. A perfectly good company, most likely, with Rs 1,650 crore of net worth before this transaction and every intention of paying. But a claim against a company is a promise, and the company holding the cash is the same company that would have to be persuaded if anybody ever disputes anything.

There is also a smaller point that sellers feel for eighteen months and that almost nobody negotiates properly. Money sitting somewhere earns something. Whatever accrued returnWhatever a sum of money earns while it is sitting somewhere, building up day by day rather than arriving in one payment. Somebody keeps it, and a document either says who or leaves the question open. builds up on Rs 113.70 crore over eighteen months belongs to whoever the document says it belongs to, and that sentence is either there or it is not. Under an escrow the sentence is usually there. A separate account exists, and somebody had to be told what to do with what the account earns. Under a holdback there is frequently no such sentence at all, for the simple reason that there is no separate account for anything to accumulate in. The money is inside the buyer's ordinary balances doing whatever the buyer's ordinary balances do. Nothing in this deal's papers sets a rate, so the accrual on this retention cannot be valued.

What does an escrow need agreed in advance that a holdback does not?

Four things. Every one of them is a negotiation that has to happen before completion, at a moment when both sides still want the transaction to close.

Somebody has to hold the money, and both sides have to be content with who that is. A holder with no instructions is worse than useless, so an agreement has to be written setting out what the holder may and may not do. Release conditions have to be settled: what has to be true, or what date has to arrive, for the money to come out, and what happens if the two sides read the same condition differently. And somebody has to decide who keeps whatever the money earns while it sits there.

The four are costs, and naming them as costs is better than pretending an escrow is free. Each takes time in a period when time is expensive. Each takes negotiation on points that feel remote while everyone is optimistic. A holder has to be found and both sides have to agree on the choice. And each of them is a place where a deal that is otherwise done can get stuck for a fortnight over a sentence.

A holdback avoids all four of those negotiations, and the way it avoids them is by leaving every one of the questions to be argued later, in worse conditions, by a party who no longer has the cash. That is the honest description. The questions have not gone away. The four have simply moved from a moment when both sides want to close and are willing to trade, to a moment when one side wants its money and the other side is deciding whether to hand it over.

How does the money come out, under each?

An escrow releases in one of three ways, and all three were written down before completion. The money comes out because a stated condition has been met. The money comes out because a stated date has arrived. Or, where the two sides read the position differently, it releases through whatever route the agreement names for exactly that situation. The third one is the one nobody enjoys negotiating and the only one that matters when things go wrong.

A holdback releases when the buyer pays it. The list ends there.

Look at the two routes and count the boxes where a human being has to choose something. The escrow route has none: a condition is met or it is not, a date arrives or it does not, and the named route is a named route. The holdback route has two, and both of them belong to the party holding the money.

The release mechanic is the only part of either arrangement that decides whether the money actually arrives, and it is the part almost nobody reads. Everybody reads how much. Everybody reads how long. The sentence about how the money comes out is longer, duller, full of conditional clauses, and is the sentence the entire arrangement turns on. A reader with only five minutes for a document that retains part of a price spends all five on that sentence and none on the other two.

The same Rs 113.70 crore, put through both arrangements

Now put real rupees on it. Harivansh Packaging Limited is buying Sundarban Polymers Private Limited, the price the sellers are actually paid is Rs 1,137 crore, one tenth of it is retained, and the retention runs for eighteen months. Nothing about the money or the timetable differs between the two arrangements, and a comparison is only fair on that condition.

As an escrow, Harivansh Packaging pays out Rs 1,137 crore on the day of completion. Rs 1,023.30 crore of that goes to the sellers and Rs 113.70 crore goes to a third party. The sellers end the day with Rs 1,023.30 crore in hand and Rs 113.70 crore sitting in an account whose release terms they read and signed weeks earlier.

As a holdback, Harivansh Packaging pays out Rs 1,023.30 crore on the day of completion and keeps Rs 113.70 crore. The sellers end the day with Rs 1,023.30 crore in hand and a claim on a buyer that is holding their money.

Rs 1,023.30 crore reaches the sellers on the day in both arrangements, and the remaining Rs 113.70 crore is in one case placed where a written mechanic moves it and in the other case in the pocket of the party who would have to be persuaded. That is the comparison in a single line, and it is the line worth carrying away.

Now turn the same day around and look at it from the buyer's side. The buyer's side is where the two arrangements stop being two spellings of one idea. Under an escrow, Rs 1,137 crore leaves Harivansh Packaging on completion day. Under a holdback, Rs 1,023.30 crore leaves. A holdback leaves Rs 113.70 crore less cash for Harivansh Packaging to find on the day, and it is not a trivial amount for a buyer that funded this purchase out of Rs 140 crore of cash it already had, plus Rs 1,000 crore it borrowed new.

The asymmetry explains something that otherwise looks like mere stubbornness. A buyer negotiating hard for a holdback rather than an escrow is not only arguing about who has to act in month nineteen. The same buyer is also arguing about how much cash it needs on the table in month zero. The two advantages arrive in the same clause, and only one of them is ever discussed.

One thing neither arrangement changes: whether a claim is payable at all. Payability is decided by an entirely different set of lines in the same document, a de minimisA floor for small claims. Anything under it is disregarded rather than reduced, so it never gets added to anything. of Rs 1.14 crore, a basketA running total that surviving claims must exceed before any payment happens. Under it, a buyer can prove a genuine loss and collect nothing. of Rs 11.37 crore and a ceiling of Rs 227.40 crore, all struck on the same Rs 1,137 crore. The three thresholds settle whether anybody is owed anything. A holdback and an escrow settle only where the money sits while that question is being answered.

How does anybody actually use this?

Three readers pick up the same three lines of a document and take three different things out of them, and not one of the three is asking the custody question set out above.

A lender to Harivansh Packaging is reading for the cash. Under an escrow, Rs 1,137 crore has left the buyer on completion day and the lender's borrower is that much lighter. Under a holdback, Rs 113.70 crore of the price is still inside the borrower and still owed. The two arrangements give two different pictures of the same company on the same date, and a lender sizing its exposure needs to know which one it is looking at. The press release says the price, and the price is the same either way, so a hurried reading of it will not reveal the retained liability at all.

An analyst covering Harivansh Packaging is reading for the reconciliation. The announced price and the cash that actually moved will not agree under a holdback, and the gap is not an error. How a retained amount is presented in a set of accounts is a measurement question and belongs with the people who settle measurement questions, but the analyst's job before that is simply to know that a gap of this shape has an explanation and to go and find which one it is. An analyst who assumes the announced price left the buyer on the day has quietly assumed an escrow.

An adviser on the sellers' side is reading for the exit. The sellers are private holders who will have no further involvement once completion happens, and for them the retained tenth is not a balance sheet item, it is the last part of the sale still in play. The adviser's first question is not how much or how long, both of which the sellers already know, but who holds it and what makes it come out. Those two answers decide whether the sellers can plan around the money or merely hope for it.

What is checked whenever a document retains part of a price?

Five things, and they take about a minute once they are known. How much is retained. For how long. Who is holding it. Which event releases it. And who keeps whatever it earns while it waits.

The two that get published are the two that do not decide anything, and the three that decide everything have to be sought out. That is not a conspiracy. An announcement is short and the amount and the period are the parts that summarise easily. But it does mean that reading an announcement carefully tells a reader nothing useful about a retention, and that anyone forming a view from one is forming it from the least informative half.

Two of these five sound like they might be the same question and are not. Who is holding it is a fact about today. The release trigger is a rule about a day in the future. A retention can be in a third party's hands with a release condition nobody can agree on, in which case the custody is fine and the mechanic is broken. A retention can also be in the buyer's hands with a clear and generous release date, and that is better than it sounds. Either one on its own misleads, so both have to be checked, always.

Two more things this same mistake is often bundled with, and both are worth separating out from a retention. Deferred considerationPart of a price the buyer agrees to pay on a later date for reasons of its own, such as spreading its funding. Deferred consideration is about timing rather than about anything having gone wrong. is money the buyer is going to pay later for its own reasons, and it is not being held against anything. Set-offKnocking one amount owed against another so that only the difference actually changes hands. Set-off saves a payment, and it also settles who ends up chasing whom. is the mechanism by which a buyer holding retained money reduces what it hands over rather than paying and then claiming back. Neither is the same thing as a retention, and both get called one in casual conversation.