Escrow provisions in M&A transactions, part II of II.(Mergers, IPOs, and Venture Finance: Equities)(Professional standards)

Escrow accounts are funds that are carved out of the seller's proceeds for the benefit of buyers in order to secure indemnification obligations under M&A transactions. However, there are a couple of alternatives to fully funded escrow accounts that both parties may wish to consider.

Increasingly, buyers and sellers are turning to M&A insurance in order to provide additional protection for liability concerns, effectively transferring some or all of the risk associated with indemnification claims to a third-party insurer. Either party may pay a premium in the 3-5% range of the total limit of the liability, in order to further protect themselves from losses arising from unknown or undisclosed liabilities, including: pending or threatened litigation, environmental contingencies, tax exposures, and or specific warranty/indemnity obligations. This option does necessitate additional effort and costs for both the buyer and seller, as the insurance carrier will need to perform its own, independent due diligence prior to agreeing to any transactional insurance.

Another approach or adjunct to fully funding escrow accounts involves the use of earnouts or contingency payments. These are performance-based components of the final purchase price. In these cases, the buyer agrees to pay the seller a future amount, (i.e., a percentage of revenues or profits generated over a 2-3 year period) as a shareholder consideration subject to satisfying certain performance criteria. This scenario is more likely to occur when a privately held organization is being acquired, and while it doesn't eliminate the need for an escrow account, it can reduce the amount placed into escrow and subsequently increase payout to shareholders at closing.

Please note that while earnouts are designed to help close the gap between seller and buyer expectations, there are no assurances or guarantees that the earnout's revenue or performance goals will be reached, thus making litigation more likely.

Marshall Warwaruk, vice president, Corum Group, 10500 NE Eighth St., Bellevue, Wash. 98004; 425/455-8281. E-mail: mwarwaruk@corumgroup.com.

 Company/           Acquired by    Price/Terms       Revenues    Multiple Description  Mapics (MAPX)      Infor Global   $320,390,000   $172,800,000      1.85                    Solutions        Terms: All Cash    * ERP software for manufacturers  Corio (CRIO)       IBM (IBM)      $161,000,000   $70,200,000       2.29                                     Terms: All Cash    * Application service provider  V Communications   BVRP           $13,500,000     $8,300,000       1.63                    Software         Terms: $8.5 MM cash/                                     shares/$5MM earnout    * Utilities software for the PC market  Info Systems       MTM            $13,200,000    $58,000,000       0.23                    Technologies     Terms: $6.8MM cash/                    (MTMC)           $3.2MM shares/$1.7MM    * IT reseller and IT consulting earnout