Holdbacks and Escrow in a Business Purchase: Why Part of the Price Waits

In many business deals, the seller does not receive the whole purchase price on closing day. A portion is held back by the buyer, or deposited with an escrow agent, and released later if everything the seller promised turns out to be true.

For a buyer, a holdback is practical protection. For a seller, it is money already earned that depends on how the release terms are drafted. This guide explains how holdbacks and escrow work in a BC business purchase and what each side should look for in the agreement.

Holdback, escrow and earnout: three different things

These terms are often used loosely, but they describe different arrangements:

• Holdback. The buyer keeps part of the price after closing and pays it to the seller later, less any agreed deductions. The money stays with the buyer, so the seller's protection depends largely on the contract.
• Escrow. Part of the price is paid to a neutral third party, often a lawyer's trust account or a professional escrow agent, under a written escrow agreement. The funds are released only on the conditions both sides agreed.
• Earnout. Part of the price depends on how the business performs after closing. That is a pricing mechanism rather than security, and it raises its own issues.

There is no single statute that governs a private holdback or escrow. They are creatures of contract, which is why the wording of the purchase agreement and any escrow agreement matters so much.

Why buyers ask for part of the price to wait

Once a buyer has paid in full, recovering money from a seller for a broken promise can mean a claim, and possibly a lawsuit. A holdback gives the buyer a fund to draw on instead. It typically backs up:

• Representations and warranties. Statements about the financial statements, contracts, employees, equipment, taxes and lawsuits. If one proves untrue, the buyer may claim against the holdback.
• Indemnities. Specific promises by the seller to cover identified risks, such as a known dispute or a tax reassessment for a period before closing.
• Post-closing price adjustments. Final figures for working capital, inventory or receivables that are not known until after closing.
• Undisclosed liabilities. Debts or obligations that surface after closing. Our guide to liabilities a buyer can inherit explains why this risk differs between share and asset deals.

Working capital adjustments

Many agreements set a target level of working capital, roughly current assets less current liabilities, that the business should have on closing. Because the true number is only known after the books close, the price is often paid on an estimate and adjusted afterwards.

As a simple illustration only: if the agreed target is $200,000 and the final closing statement shows $170,000, the price would come down by $30,000. A holdback lets that adjustment come out of money the buyer still holds, rather than requiring the seller to pay it back. A good agreement says who prepares the closing statement, how long the other side has to object, and who resolves a disagreement, often an independent accountant.

Non-resident sellers and section 116 of the Income Tax Act

Tax law adds a specific reason for a holdback when a seller is not resident in Canada. Under section 116 of the federal Income Tax Act, a buyer who acquires taxable Canadian property from a non-resident can become liable for part of the seller's tax. According to the Canada Revenue Agency, taxable Canadian property generally includes real property in Canada, property used or held in a business carried on in Canada, and shares of corporations not listed on a designated stock exchange if, at any time in the previous 60 months, more than half their value came from Canadian real property or resource property.

• The buyer's exposure. Unless the seller obtains a certificate of compliance from the CRA, the buyer is generally liable for 25% of the amount by which the cost exceeds any certificate limit, and 50% for some kinds of property, such as certain depreciable property. That amount must be remitted within 30 days after the end of the month in which the property was acquired.
• The seller's notice. A non-resident seller must notify the CRA within 10 days after the disposition, unless notice was given in advance.
• The buyer's protection. The Act lets the buyer withhold the amount from the price. In practice, the purchase agreement usually provides for a holdback that is released once the certificate arrives, or remitted to the CRA if it does not.

The buyer is not liable if, after reasonable inquiry, it had no reason to believe the seller was a non-resident. That is why buyers ask for a residency representation and supporting evidence before closing. There are also narrower exceptions, for example for certain treaty-protected property where the buyer gives the CRA notice within 30 days of the purchase.

Terms both sides should negotiate

Whether you are buying or selling, the details decide how a holdback works in practice:

• Amount and duration. How much is held, and for how long. The period often tracks how long the seller's warranties survive after closing.
• Who holds it. The buyer, or an escrow agent with written instructions. Escrow gives a seller more comfort that the money will be there.
• Interest and costs. Who receives interest on the funds and who pays the escrow agent's fees.
• Release conditions. Fixed dates, staged releases, or release on a specific event such as a tax certificate or a lease consent.
• Claims process. What notice the buyer must give, by when, with what detail, and what happens to the amount in dispute while the rest is released.
• Relationship to other remedies. Whether the holdback is the buyer's only recourse or just a first source of payment, and how it fits with any cap or minimum threshold on claims.

These terms sit alongside the other key terms in a business purchase agreement, and they should be read together.

For sellers: protecting money you have earned

A seller's main risk is that the holdback becomes a bargaining chip. Vague release conditions, open-ended claims or a right to set off unrelated amounts can delay payment for months. Clear deadlines for claims, an obligation to release undisputed amounts, joint instructions to an escrow agent, and a defined dispute process all reduce that risk. Where a seller is also financing part of the price, the holdback interacts with vendor take-back financing and both should be planned together.

When a release is refused or a claim is disputed, the agreement's dispute clause usually decides the next step. If that fails, it can become a contract claim, which is another reason to draft the process carefully at the start.

Negotiating payment terms? Have the holdback reviewed first

Our business purchase and sale lawyers can draft or review holdback and escrow terms, the release conditions and claims process, and the tax steps needed when a seller is not resident in Canada.

Call 604-259-2844 or send us a message to arrange a consultation at our Vancouver office.