Escrow and indemnification at closing
How the escrow account actually gets set up, funded, and administered once the deal is signed.
How the escrow agreement actually gets executed and funded
The escrow terms negotiated in the purchase agreement, and previewed in the LOI if you followed the LOI essentials guide's advice, get formalized into a standalone escrow agreement signed by buyer, seller, and the escrow agent at or immediately before closing — a separate document from the purchase agreement itself, even though it implements terms the purchase agreement already set.
Funding happens as part of the closing wire flow: instead of the full purchase price going to the seller, a portion — typically the 10 to 20% of price negotiated for escrow (see the negotiation sticking points guide) — is wired directly to the escrow account instead, with the seller receiving the balance. This isn't a separate step the seller has to remember to do after the fact; it's built into how the closing funds actually move.
Because the escrow amount comes out of what the seller receives at closing rather than being an additional cost the buyer bears, sellers experience it directly as money they don't get today — which is exactly why escrow terms get negotiated hard rather than treated as a formality.
Who holds the funds, and how a claim gets made
A neutral third party — typically a bank, an attorney's trust account, or a dedicated escrow services company — holds the funds, not the buyer or the seller directly. Neither party can unilaterally access the account; release requires either both parties' written agreement or, if they disagree, resolution under whatever dispute process the escrow agreement specifies.
To make a claim, the buyer typically has to deliver written notice to the escrow agent and the seller within the escrow period, describing the specific breach and the amount claimed. A general "something seems off" isn't sufficient — the notice needs to tie back to a specific representation or warranty in the purchase agreement that turned out to be false, or a specific liability the seller agreed to indemnify against.
The seller then has an opportunity to respond, often within a set number of days, either agreeing to release the claimed amount or disputing it — which is where the basket and cap negotiated earlier (see the negotiation sticking points guide) actually get applied: a claim below the basket threshold typically isn't payable at all, and total claims are limited by the cap regardless of how many separate issues surface.
What happens to the balance if no claim is made
If the escrow period passes with no claims made, or once a claim is finally resolved, the remaining balance releases to the seller automatically per the terms of the escrow agreement — without requiring a new negotiation or the buyer's active cooperation beyond what was already agreed at closing.
This is worth knowing going in: escrow isn't a slush fund a buyer can tap into for buyer's remorse or unrelated post-close disappointment with how the business is performing. It exists specifically to cover breaches of the seller's actual representations and warranties, and a buyer who tries to make an unsupported claim just to delay release risks damaging the post-close relationship, and potentially a claim for bad faith, without any real chance of prevailing.
A calendar reminder ahead of the escrow release date is worth setting on your own end — it's easy, months after a busy closing, to lose track of when the window to raise a legitimate issue actually closes.
Coordinating the escrow release with the working capital true-up
The escrow period and the working capital true-up (see the working capital pegs guide) run on different, overlapping timelines: the true-up typically resolves within 60 to 90 days of closing, while the escrow period runs much longer, 12 to 18 months. They're not the same mechanism, but a working capital shortfall the seller doesn't pay when the true-up comes due can sometimes be pursued through the escrow instead, if the purchase agreement is drafted to allow it.
Whether an unresolved working capital true-up claim can actually be collected from escrow — rather than requiring separate collection action against the seller directly — depends entirely on how the purchase agreement defines what counts as an indemnifiable claim. Worth confirming explicitly with your attorney at drafting time rather than assumed, since it materially changes how much real recourse you have if a seller who's already been paid the bulk of the purchase price simply doesn't pay a working capital shortfall when it's owed.
The practical takeaway: don't treat escrow and the working capital true-up as two unrelated boxes to check. Understanding how they interact — and making sure your purchase agreement actually connects them if you want that protection — is worth a specific conversation with your attorney before signing rather than assuming it's handled.
This guide is for informational and educational purposes only. It does not constitute legal, tax, financial, investment, or lending advice, and is not a substitute for advice from a qualified attorney, accountant, lender, or other licensed professional.