Definition. A portion of the purchase price withheld at close, held by a third-party escrow agent, to secure the seller's indemnification obligations. Typical lower-middle-market escrow is 5% to 10% of purchase price, held for 12 to 24 months, released to the seller minus any indemnification claims at the end of the survival period.
The escrow is the practical mechanism that makes the indemnification cap real. Without an escrow, the buyer would need to sue the seller to recover indemnification claims, which is expensive and uncertain. With an escrow, the buyer can simply notify the escrow agent of a claim and the funds are held until the claim is resolved.
Escrow versus holdback (the buyer holding back funds from the seller rather than third-party escrow) is largely a matter of seller leverage. Larger and more sophisticated sellers typically insist on third-party escrow; smaller deals sometimes accept a buyer holdback. The seller’s preference should always be third-party escrow.