On the heels of many seemingly smooth business deals, a buyer may have doubts. Sometimes they question whether certain details of the business meet regulatory standards. They may also be concerned with fraudulent issues. To quell their apprehension, a buyer will sometimes request a holdback.
A holdback is a portion of the purchase price that is not paid at closing. In a holdback, the buyer wants to protect themselves by “holding back” funds — i.e., a portion of the purchase price — at closing. A buyer may be concerned there are hidden skeletons in the closet of the business they are purchasing.
What follows are typical examples of situations that might prompt a buyer to request a holdback…
What Could the Buyer be Concerned About?
A buyer can find many things with which to concern themselves. Most of the time, they are simply being prudent. However, there are situations that have merited previous buyer holdbacks.
Let’s say a buyer is purchasing a manufacturing company. They may be concerned about the environmental condition of the property. Any type of business that has industrial activity is at risk for contamination. Assessment and cleanup of the property can be expensive, time-consuming, and risky.
A buyer may be apprehensive that hazardous materials have leaked onto the property or that they have been stored improperly. These are sound reasons to request a holdback. A holdback offers a buyer the opportunity to have inspections of the property and to determine the costs and risks related to cleanup.
A buyer could also be worried about future liability to employees working on the property or nearby dwellings and their inhabitants.
These things can affect the value of the business and can ultimately be a hindrance to the future performance of the business.
Another possible concern to business buyers is fraud. This is understandable because we are facing a time when fraudulent activities are at their height. In fact, the Federal Trade Commission says elements of fraud can be found in many business opportunities, so much so that it ranks in the top 10 of its database of fraudulent activities.
These are just examples of why a buyer might request a holdout in a business transaction. If a buyer is not comfortable with taking a seller at their word over certain aspects of the business deal, they may request a holdback.
There is usually a designated time frame set to allow the buyer to be satisfied that there are no unknown problems that might affect the business’s future revenue. It’s worth mentioning that the buyer may also use a holdback to buy time to serve their own purposes, such as relocating the business or gathering a customer base.
How Do I Know the Buyer has the Funds?
Usually, any holdback amount is paid into escrow with a third-party agent, such as a law firm or escrow agent. This usually offers some protection and a guarantee that the funds are there if the buyer is not willing or unable to make payments later on.