Escrow Shares: Meaning, Types and Benefits

Key Highlights

• Shares placed in escrow accounts during certain financial transactions, such as mergers and acquisitions or corporate restructuring, are known as escrow shares.

• An escrow agent oversees the escrow account and assists both parties in fulfilling the terms and conditions of the transaction. A third party typically holds escrow accounts.

• An escrow safeguards all the parties in the transaction. The escrow protects the buyer since it ensures that the seller has delivered the items, whilst the seller is protected by having the money deposited into the account.

What are Escrow Shares?

Let’s start with the escrow shares definition. Escrow shares are a specific kind of financial instrument. A third party, often a financial institution, holds shares on behalf of the principal parties to make the transactions. In most cases, this arrangement is only temporary. It serves to safeguard the interests of both parties up until the predefined requirements are satisfied. Escrow shares are primarily used to give parties to a financial transaction an extra measure of security and assurance.

The shares will be held in escrow accounts so that the parties can make sure that their interests are protected. It also ensures the transaction's terms and conditions are satisfied before the shares are released.

Importance of Escrow Shares in Financial Transactions

Escrow shares are essential in financial transactions because they provide an extra measure of security and assurance for all parties. They can assist in reducing the likelihood of disputes, preventing fraud, and guaranteeing that each party fulfils their commitments.

Escrow shares can also be used as a tool to motivate commitment from important firm stakeholders. Company founders and executives can help their company attract investors and enhance confidence in shareholders by putting a percentage of their shares in escrow. They can show their commitment to the long-term success of the company.

Example of Escrow Shares

The minimum subscription for an IPO in India is 90% of the shares issued. Under normal circumstances, the minimum quantity for countries like the USA is 100 shares. However, those quantities may vary from issue to issue.

The company cannot distribute the shares and must refund the money if the claims have a lower minimum limit. In the event that firm A issues 10,000 shares, all of the proceeds from the IPO will be deposited in an escrow account. The securities will be printed with the escrow agent.

If the company receives applications for more than 90% of the issue, for instance, 9,700 shares, the terms of the transaction will be met. So, the investors will receive the shares allotted to them, and the company will receive the money. If less than 90% of the shares are applied, the terms of the transactions will not be met. So, the securities aren't transferred. The money shall be returned to the shareholders.

When are Escrow Shares?

Shares are usually escrowed when one of the parties wants protection from the possibility of non-payment or non-delivery of claims. The following are some possible scenarios.

1. Mergers and Acquisitions: In a takeover, the target business may request a specific portion be put in escrow as insurance against the acquirer's failure to make payments. This is usually between 10% and 15% of the shares. As a result, the acquirer doesn’t obtain ownership of shares if they fail to pay the agreed-upon amount. Similarly, money or securities may be held in escrow until the relevant authorities have given their consent to the transaction.

Additionally, during a long merger or acquisition process, the purchase price may have to be changed. As a result, maintaining the securities in escrow enables modifications as per the variations in cost.

2. Reorganisation or Bankruptcy: If a firm declares bankruptcy or is awaiting approval while reorganising, operations may need to be put on hold. The company shares are changed to escrowed shares in this situation.

3. Employee Compensation: Shares of the business are given to employees as rewards or remuneration. The shares may be issued at a price lower than the market value, which is known as the Employee Stock Option Plan (ESOP). In such cases, there is typically a vesting period or a set amount of time that employees must wait before becoming shareholders. They are referred to as restricted shares.

The shares are held in an escrow account from the granting date until the vesting date in this scenario. The granting date is the day employees get their shares. When the allotted amount of time has passed, the claims are given to the employees. This is done to provide additional motivation for the employees to stay on board with the firm. They could acquire ownership of the shares if they do. If not, the agreement's conditions aren't met, and the escrow agent returns the funds to the firm.

Types of Escrow Shares

Here are some of the types of escrow shares in the market

Voluntary Escrow

Escrow agreements that all parties in a transaction voluntarily enter into are referred to as voluntary escrows. This kind of escrow is frequently utilised when the parties want to show their dedication to the trade or when they want to safeguard themselves from potential threats.

For instance, in the event of an IPO, the firm’s founders and executives can voluntarily escrow a portion of their shares to show their long-term dedication to the company. This may promote a greater valuation for the company and aid in increasing investor trust.

Involuntary Escrow

Mandatory escrow, also referred to as involuntary escrow, is a contract that a regulatory agency or other governing body imposes on one or both parties in a transaction. This kind of escrow is frequently used to make sure that laws are followed. They also safeguard the interests of third parties, including minority shareholders.

Company restructuring is a good example of this scenario. To safeguard the interests of minority shareholders, a regulatory body may demand that certain shares be placed in escrow. This will ensure that minority shareholders will receive fair treatment. This ensures the protection of their rights throughout the restructuring process.

Conditional Escrow

The release of shares held in escrow under a conditional escrow agreement is subject to the fulfilment of certain requirements. These prerequisites may be linked to the company's performance or other aspects of the transaction, like regulatory compliance.

For instance, in an IPO, the company may have to meet specific revenue or profitability targets before escrowed shares can be released. This can motivate individuals to work towards these objectives by aligning their interests with the long-term success of the company.

Conclusion

The shares are held in escrow so that the parties may make sure that their interests are protected. It helps in ensuring that the transaction's terms and conditions are satisfied before the shares are released. Escrow shares can also be used as a tool to motivate commitment from important firm stakeholders.

Company founders and executives can attract investors and foster confidence in shareholders by putting a percentage of their shares in escrow. They can demonstrate their commitment to the long-term success of the company.