Almost There (I Promise!) – Escrow

Escrow serves several important functions in the sale of a business. The primary purpose is the same as that for buying or selling a house, which is to provide a neutral third party to handle all monies and paperwork until all conditions of the escrow are observed. That being said, an escrow for a business transaction has different sets of laws to follow and generally involves many other parties, unlike escrow for buying a home. 

When selling a business, escrow is often required if a third party, such as a bank, is involved. I also recommend using an escrow agent to assist with the closing of smaller transactions if each party is not represented by an attorney. 

During any closing, multiple adjustments and prorations must often be made to account for timing differences between when bills are paid and when a change of possession occurs. Among others, these can include lease payments, utilities, property taxes, and accounts receivable. Escrow can assist in making these closing adjustments and prorations.

Typical Duties of the Escrow Holder

The typical duties of the escrow holder in a transaction include:

  • Collecting and disbursing all closing funds according to escrow instructions.
  • Distributing final transaction documents to all parties.
  • Drafting escrow instructions according to the terms and conditions of the purchase agreement.
  • Filing and recording all necessary documents with the appropriate authorities.
  • Filing UCC-1 Financing Statements with the secretary of state when seller financing is involved.
  • Holding earnest money in a safe and secured escrow account pending the closing.
  • Providing a Notice to Creditors of Bulk Sale, if included in the instructions.
  • Ensuring that secured creditors are satisfied and coordinating any necessary payoffs.
  • Notifying and obtaining clearances from county, state, and federal agencies, as required.
  • Notifying the county tax collector.
  • Obtaining a Corporate Status Report from the secretary of state of all entities involved in the transaction, and confirming the entities exist and are in good standing.
  • Pro-rating and paying the rent, deposits, taxes, and other expenses out of the proceeds, as required.
  • Performing a UCC-1 lien and property tax search on the business to make sure that clear title can be conveyed.
  • Preparing estimated closing statements prior to the close of escrow.
  • Preparing fictitious business name statements.
  • Preparing final closing statements for the parties and accounting for the disposition of all funds deposited in escrow.
  • Preparing separate buyer and seller settlement statements reflecting that all funds are being handled through escrow.
  • Requesting demands from existing lien-holders and receiving claims.
  • Handling UCC-3 terminations, amendments, and/or releases of lien. 

Considerations Around Escrow

Because the escrow officer is a neutral third party, they do not negotiate or try to settle any disputes between the parties in the transaction. This includes providing legal advice and resolving disagreements, which are the responsibilities of the attorney or business broker in the transaction. The escrow officer also doesn’t send notice of the completion of the sale to the landlord or to the utility and insurance companies.

It is important to note that your broker can’t act as the escrow agent because they can’t provide a fiduciary relationship to both parties. It would represent a compromise of the broker’s ethics if they simultaneously function as the escrow agent.

It is also important to note that not all escrow agents have the same functions. For example, a holding escrow is when an escrow agent limits their services to the holding of funds. In this case, the agent may hold the buyer’s earnest money deposit and may not perform any other services.

It’s not an absolute requirement that you use an escrow company. Certain states, such as California, require that you comply with specific laws, such as bulk sales laws, and typically only escrow agents offer this service. 

You should, however, strongly consider the use of an escrow agent. Why? It’s always a good idea to have an objective third party hold the funds, make sure there are no additional encumbrances against the business, and ensure you and the buyer are in agreement on the closing prior to releasing funds.

The primary purpose of escrow for a business transaction is the same as that for buying or selling a house, which is to provide a neutral third party to handle the money and paperwork.

Bulk Sale

A “bulk sale” refers to the sale and transfer of nearly all of a business’s inventory to a single buyer where the transaction is not part of ordinary business. Bulk sales laws are meant to protect creditors by giving them notice when one occurs. This notice is to stop business owners from buying inventory on credit then liquidating the inventory to a single buyer and skipping town with the cash. 

Bulk sales statutes require advance notice, often released 14 to 30 days before the sale, typically through publication in a newspaper. Creditors are then given the opportunity to submit claims to the escrow holder. Most states, however, have repealed the bulk sales laws because in reality, they have done little to protect creditors. Additionally, bulk sales laws only apply to certain types and sizes of businesses.

Is the escrow process the same in every state?

No. The closing process is generally easier in states that have repealed bulk sale statutes than those that have not. Additionally, business sales on the West Coast tend to be handled by escrow agents, whereas those on the East Coast tend to be handled by attorneys.