The short answer is no you are not legally required to use an escrow when selling your business.  Escrow is a process where a neutral 3rd party oversees the transaction and provides assurance that no funds or title will exchange hands until all of the instructions in the transaction have been followed. 

The escrow agent’s job is to follow the escrow agreement, hold any deposited funds and manage the documents until the change of ownership is complete.  The escrow services are usually provided by an escrow company that specialize in this but can also be handled by any independent third party like an attorney or CPA.  

The question of “need” is really up the buyer and seller.  As all professional services offer assurance and security, there is a cost to the service.  If there is money to be deposited and held prior to the close of the business sale than an escrow is a good idea.  This way there is someone other than the two owner’s involved in the transaction to oversee the terms of the deposit.  Deposits in a business sale are a little different than in a real estate deal.  Due to the significant due diligence process in selling a business, losing a deposit is rare.  Most small business sales do not require a deposit and thus an escrow company is not involved.

There are additional benefits for using an escrow even if a deposit is not required.  They are used for the ease of managing the paperwork, financing documents, lease agreements, bulk sale notification and the final settlement statement.  Depending upon the complexity of the deal, it is often times nice have a single location where all the documents can be managed.  The escrow officer will number and track all the paperwork and gives place other than the seller’s business where the transaction work can be handled. 

Lenders also typically require escrow because they will send the financing directly to escrow and then escrow will wire out the final proceeds.  This assures the lenders that the legal requirements and documents are signed/approved by both parties before any money is wired out.  This is handled through a closing statement that shows the purchase price and allocated costs to each side. This statement is required to be signed by both parties and often includes professional fees, taxes, pro-rated rent, insurance, etc.

On small, all cash deals where a cashier’s check is brought in at the final date of signature, escrow is not required.  If you have a large transaction, a lender and/or alot of paperwork then you should consider using an escrow service.  Sometimes your lawyer will provide this as part of the deal and other times you will need an outside company.  Either way, understanding that escrow is only a fancy name for managing the sales transaction might make it easier for you to determine if you need it.

This entry was posted on Tuesday, December 1st, 2009 at 2:40 pm and is filed under Strategic Advisors, Selling a Small Business, Sell Your Business, Exit Stories, Emotional Selling, Exit and Answers, Buy a Business. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.