Holdback vs. Escrow (Purchase Price)

In a business purchase, the seller makes promises that outlast closing: that its representations and warranties were true, that working capital matches the estimate, that pre-closing taxes are paid. A promise is only as good as the seller's ability to pay, and a seller who has spent or distributed the proceeds is a poor defendant. A holdback solves this by leaving part of the price unpaid until the risk period ends.

The term is used loosely. In a strict holdback, the buyer keeps the money, usually in its own account, and owes it to the seller on the release date less any valid claims. In an escrow, the money is paid at closing to an escrow agent, who holds it under a written escrow agreement and releases it only on the parties' joint direction, a final decision or the agreed release terms. Agreements sometimes say holdback when they mean escrow, so read the mechanics, not the label.

Do not confuse either with a construction holdback. Ontario's Construction Act requires each payer under a construction contract or subcontract to retain a statutory holdback from payments, to protect those with lien rights such as subcontractors and suppliers. That is a separate regime with its own rules and has nothing to do with the price of a business.

Sellers usually prefer escrow. Money retained by a leveraged buyer may be out of reach if the business struggles, and the buyer's lender holds security that ranks ahead of the seller's unsecured claim. Buyers prefer a holdback because it is cheaper and lets them withhold payment while a claim is investigated. A common compromise is escrow for the indemnity fund and a buyer-retained holdback for a short, small price adjustment.

The agreement should say exactly which obligations the fund secures:

• Indemnity claims. The most common use: the fund is the buyer's first source of recovery for a breach of a representation or a specific indemnity under the indemnification clause, and any loss above the fund remains a direct claim against the seller.
• Purchase price adjustments. A separate, smaller fund often secures the post-closing working capital adjustment and is released once the final closing statement is settled.
• Specific known risks. A pending lawsuit, an open CRA audit, a landlord consent not yet obtained or a key contract up for renewal can justify a targeted holdback released when that one risk resolves.
• Tax clearance. The section 116 holdback for non-resident sellers, discussed below.

A holdback is not an earn-out. Holdback money is price the seller has already earned, and the only question is whether claims reduce it. Earn-out money is owed only if future targets are met.

Release schedule. Releases usually track the survival period of the representations the fund secures: for example, half after 12 months and the balance at 18 or 24 months. Each release is reduced by claims that have been notified but not resolved. Sellers should limit that reserve to a good-faith estimate of each claim rather than whatever figure the buyer chooses to assert.

Claims process. The agreement should set out how a claim is notified, what detail it must contain, how long the seller has to dispute it, and what happens to disputed money. Usually it stays in the fund until the parties agree or a court or arbitrator decides.

Set-off. Separately from the fund, buyers often ask for the right to deduct claims from other amounts owed to the seller, such as a vendor note or earn-out payments. Sellers should limit set-off to amounts that are agreed or finally determined, so a contested claim cannot be used to stop paying a fixed debt.

Escrow agreement. An escrow agent acts only on the written terms of the escrow agreement, which should cover the agent's fees, how the funds are invested, who receives the interest and what the agent does if it receives conflicting instructions.

Escrow is also used before closing, for deposits under a letter of intent; see deposits and break fees in a letter of intent. Where part of the price is paid over time instead, Lamba Law's Vendor Take-Back and Earn-Out Calculator shows how the deferred pieces fit together.

A different holdback arises when the seller is not resident in Canada. Under section 116 of the Income Tax Act, a non-resident disposing of taxable Canadian property must notify the CRA and can obtain a certificate of compliance by paying or securing the tax. Taxable Canadian property includes real property in Canada, property used in a business carried on in Canada, and private-company shares that derived more than half their value from Canadian real property or resource property at any time in the previous 60 months. Inventory of a business carried on in Canada, other than real property and resource property, is generally excluded from these rules. If no certificate has been issued, the buyer becomes liable for 25% of the cost of the property, or 50% for certain property such as depreciable taxable Canadian property and real property in Canada that is not capital property. The amount must be remitted within 30 days after the end of the month in which the property was acquired. The CRA's Information Circular IC72-17R6 confirms the buyer may withhold that amount from the price.

Buyers therefore hold back the applicable percentage until the section 116 certificate arrives and then release it; that entry explains the seller's filing and how the certificate limit works. A buyer is not liable if, after reasonable inquiry, it had no reason to believe the seller was a non-resident, so residency representations and declarations belong in the closing documents.

Nadim Bishara buys the assets of a Burlington landscaping business from Monique Gagnon's corporation for $1,500,000. Nadim's bank finances most of the price, so Monique refuses a buyer-retained holdback: her money would sit with a leveraged buyer whose bank ranks ahead of her. The parties agree to escrow $150,000 with Nadim's lawyer as escrow agent. Half is to be released at 12 months and the balance at 18 months, each less pending claims.

In month 10, a commercial customer sues for $22,000 over defective work done before closing, a pre-closing liability Monique's corporation agreed to indemnify. Nadim gives notice under the agreement. At 12 months, the agent releases $53,000 to Monique, which is the $75,000 instalment less the $22,000 claim reserve.

The claim settles for $15,000. At 18 months, the agent pays $15,000 to Nadim and releases the remaining $82,000 to Monique. Monique receives $135,000 of the $150,000 escrow, Nadim is made whole without suing, and neither side had to rely on the other's word about where the money was.