What is Escrow? A Comprehensive Guide for New Business Owners

Escrow is a financial arrangement in which a third party holds and regulates the payment of funds or the transfer of property between two parties. This ensures that the transaction is completed according to the terms agreed. Escrow is commonly used in business acquisitions to protect both buyers and sellers from fraud or non-performance.

To date, the FE International team has executed over 1,000 deals, all of which were transacted through a safe and secure escrow process. So, with our strong track record in this area, why are we talking about this again?

Unfortunately, escrow disputes and fraud are a costly risk. In rare situations, upwards of $10M per case. practices so we thought this is as good a time as any to reiterate the importance of using an escrow service in the sale or purchase of a business (online or otherwise).

What is Escrow? A Complete Guide to the Escrow Process

So, what is escrow and why slow everything down by using an escrow process? The problem begins with a misunderstanding of how escrow can protect you and how long it actually takes. Look at escrow like medical insurance – you don’t like paying for it, but when things go wrong, you are glad you did. Being in the privileged position of seeing 50+ deals completed a year first hand, I can certainly tell you that things do go wrong. Having bought 4 online businesses myself over the past 2 years, I sympathise with the dilemma of speed and cost savings versus security. By the time you get to the stage of buying or selling a business, you are likely to be heavily invested in a process and trust the acquisition or sale partner (and broker). The thrill of the chase is also often overwhelming and you may just want to get your hands on the asset as soon as possible to get to work on all those “easy wins” and “no-brainer” changes that will double, no wait, triple the value of the business overnight. Sellers especially have a tendency to spend the money mentally before it even hits their account. Everyone is highly motivated to get the deal closed.

With all the will in the world, there is no such thing as the “perfect” buyer, seller or deal. Most of the time issues can be identified and mitigated by a competent broker ahead of sale, but what do you do if you are not in control of your funds or asset when you realise there is an issue? What happens if your funds or assets are held to ransom by the buyer or seller? Can you afford a legal case? Would you trust your broker to remedy a situation rather than think of their own pockets? What options are available to you if you sell privately?

These are valid (and very real) concerns that you should be thinking about before you pull the trigger on an acquisition or sale.

How Does Escrow Work?

Escrow is not a new notion created in this tech era, it has been used since the 16th century, where a trusted third party would be enlisted to hold the money while the exchange took place in the sales of goods or property – often when a scroll containing the deeds was handed over.

Let’s clear up exactly what takes place in an online escrow process (such as that of Escrow.com) and how this protects buyers and sellers once contracts are signed and funds are secured:

Buyers:

• Tracks and verifies that the merchandise has been shipped and delivered.
• The seller is not paid until the buyer accepts the merchandise, or the inspection period expires.

Sellers:

• The seller is instructed to ship only after good funds have been received.
• Escrow provider confirms delivery of the merchandise.
• Escrow provider monitors the agreed-upon inspection period once delivery is confirmed.

Should you be an honest buyer or seller, reading these points should make logical sense to you. Issues arise when you are honest and your counterpart is not. Here at FE International, anyone suggesting a workaround from the standard Escrow.com driven process is a serious red flag.

The time taken for this process will depend on the particularities of a specific purchase agreement and the complexity of the assets being transferred. At FE International, this is one of the last steps in the sale process (with due diligence completed well ahead of time), so 1-2 weeks is fairly standard from start to finish.

So in short, use escrow and everything will be fine. Or if it is not plain sailing, escrow will usually defer to Arbitration and you can get things resolved swiftly. Case closed.

What Happens if Your Chosen Escrow Agent is a Crook Too?

Wait, what? Escrow can be bad too. Now, this is something we didn’t previously report on. Escrow is something you use to sell or buy your house, car and many other important assets throughout your life. Why throw this curveball into the mix? If you can’t trust an escrow service, who can be trusted?

Well, the answer is very simple – trust an escrow service which is licensed.

At a very simple level, the California Department of Business requires persons or companies performing escrow services over the Internet in California to comply with the licensing requirements of the California Escrow Law:

“The licensing and regulatory process ensures that companies’ owners and key employees have been subject to background checks performed by the California Department of Business Oversight, that the company’s financial condition and records are adequate, that the company is properly bonded, and that all customer funds are segregated in trust fund accounts until the terms of the escrow are met.”

Does this limit market choice of escrow services? Well somewhat, in the state of California there are only a meagre 800 independent escrow companies licensed by the Department of Business Oversight.

Why Do Some Online Brokers Avoid Escrow?

The fallout from a deal going sour can be quite extreme: loss of funds or assets, legal fees, court cases (for the buyer, seller and broker), websites losing sales or traffic with no maintenance while issues are resolves, etc. We see little to no downside in using escrow, so why would any sound individual avoid it?

To come full circle, confidence and excitement is usually enough to tempt the best of us away from sticking to a proven process. If you have spoken to a broker every few weeks for a prolonged period of time, you may well come to trust that they have your best interests at heart and, often they do. However, even those acting with the best intentions can get caught on the wrong side of fraudsters, like our friends over at Empire Flippers. They recently shared their story on how they were defrauded out of $25,000 on the sale of a client’s business.

While Justin and Joe over at Empire Flippers are honest people and likely covered the losses from their own pockets, other “one man band” brokers may not be as accommodating or honest when faced with difficult situations and you may be forced into legal action. Some brokers may just not be educated enough on the topic or avoid using such a service to pass the “savings” on to their clients. Again, while you may be led to believe your best interests are being protected, a ~0.5% transaction fee saving is rarely significant enough a cost to take the risk of not using an escrow process.

What Escrow Service Do You Use?

Escrow.com. This firm is a pioneer in the online escrow space and is fully licensed in California, Arizona and Idaho. As one of the larger online brokerage firms by volume, transaction size and geographical footprint, we have helped Escrow.com over the years to create practical processes in order to meet the requirements of online business sales, while maintaining absolute security for buyers and sellers when conducting business acquisitions and sales. Should an issue arise (which thankfully it has not to date for FE International) there is a choice of three arbitration services for swift resolutions.

Escrow.com has also recently launched a domain holding service, whereby they will hold domains in escrow against outstanding finance payments on deals. This is particularly useful for buyers and sellers as seller financing becomes more prominent on deal structures – this service helps avoid any uncomfortable conversations of missing payments or domain releases once funds have been cleared in full at the end of a deal. It is also useful for brokers engaged in domain brokering, like the team over at Flippa, as this provides a complete solution to their needs. Finally, we are in good company with Escrow.com. They are fully licensed, bonded and used by the likes of US Commercial Service, Autotrader.com, Ebay and GoDaddy and have completed over $2.5 billion in transactions over the past 10 years.

Escrow Advice: Should I Use an Escrow Agent?

What advice can I give you? Well, legally, none, speak to your attorney. If their advice cannot convince you to the merits of using an escrow service, then I will stand little chance. However, if you do like what you hear, do think twice about blindly signing their letter of engagement, or that of any other advisor, not matter how much comfort they give you. You have worked hard to get in a position to buy or sell a business, so do some research and make sure you are happy with the process you are embarking upon and that it is suitable for your online needs.

“What is Escrow?” Further reading and useful links:

Escrow.com Fee Calculator
A History of Escrow