The 3 Most Common Holdbacks in a Business Deal

Are you a fan of surprises?

I’ve been having lunch every other month with a former client who sold his business about a year ago. Besides the pleasantries and war stories, I keep asking him if there are any surprises that have popped up since the close date.

He knows why I’m asking the question.

The buyer of this company is holding back about $500k of the purchase price for various things. Thankfully, prior to closing, both my client’s counsel and I gave him a rundown of those items and did our best to constrain their definition. Now, we are keeping tabs on those things.

In most transactions, there will be holdbacks for various items. A holdback is essentially a piece of the purchase price held in reserve — most likely an escrow account — for a contingency.

The three most common holdbacks are…

Holdback #1: Working Capital

If you have a working capital target in your deal, a reserve will be set up for roughly 10 to 20% of the target.

Most deals will close at 11:59pm on a specific date with a sign-off at a trust company a few days before, which requires a “best estimate” of working capital.

The true-up period is usually 90 to 120 days afterward, allowing the buyer to firm up the actual working capital as of the close date.

Holdback #2: Warranty

Say that you offer a one-year warranty on sold items and that your warranty experience rate is about 1% of total sales.

A warranty holdback would be for 1% of the last year of sales. Any items that would be returned as warranty to the new owner would be credited to that holdback.

That “cost” is something the seller should absorb, as the warranty claims existed at the close date.

Holdback #3: Indemnification

When you sell a company, you make a series of representations, such as:

• You’ve run the business normally during the selling process

• What you told the buyer is true

• You abided by laws and regulations

Most of the time, these representations have a caveat — that you assert them “to the best of your knowledge.” These types of holdbacks range from 10 to 20% of the purchase price.

The Reality Is…

The reality of deals is that there will always be a claim against the holdbacks, especially the working capital and warranty holdbacks. 

Things get sticky when the buyer asserts an indemnification claim — that will usually set off an emotional reaction — but a really well-constructed purchase agreement will limit your exposure while allowing you to be honest in your deal.

I always implore my clients to look at the deal as a whole: Did you get what you wanted from it?

There is more to that answer than dollars.

Here at Blueprint Business Advisory, I guide my clients through the whole process, from deal origination through wrap-up. Let me help you understand the process.