What Are Escrowed Shares?

Escrowed shares are shares held in an escrow account, secured by a third party, pending completion of a corporate action or elapse of a time period leading to an event. Shares are escrowed in three common cases: merger and acquisition transactions; bankruptcy or reorganization of a company; and granting of restricted shares to an employee of a firm.

Key Takeaways

  • Escrowed shares are shares held in an escrow account, secured by a third party, pending specific actions or a time period.
  • Escrow reduces risk in a transaction by having a third party hold assets preventing one party from having to chase the other party for the assets.
  • Companies issue stock in escrow as a part of an employee's compensation whereby limitations exist on when the shares can be sold.
  • Mergers and acquisitions often require shares of the target company to be held in escrow until the deal is finalized.

Understanding Escrowed Shares

Escrow is a process whereby money or a financial asset is held by a third party on behalf of two other parties. Escrow is used in various transactions, including real estate. The assets or funds that are held in escrow remain there and are not released until all of the obligations outlined in the agreement are fulfilled. Escrow reduces risk in a transaction by having a third party hold assets preventing one party from having to chase the other party for the funds or assets.

In stock transactions, the equity shares are held in escrow–which is essentially a holding account–until a transaction or specific requirements have been satisfied. Many times, stock issued in escrow allows the shareholder to own the stock, but cannot sell the stock immediately or has limited access to selling the shares.

Examples of Escrowed Shares

Below are examples of when equity shares are held in escrow.

Employee Compensation

Oftentimes, companies issue shares of stock as a bonus or part of the company's compensation program for employees such as executives. Those employees typically must wait a specified period before selling their shares. The shares that are granted by the company are called restricted shares since the employee must wait until the vesting period has elapsed to own the shares. Between the grant date and vesting date, the shares are held in escrow. Upon the vesting date, the shares are released to the employee.

The reason companies hold stock in escrow for employees is that it provides an incentive for the employees to remain with the company for the long-term. Shares of stock can be held in escrow for anywhere between one to three years before an employee or executive can cash them out.

Mergers and Acquisitions

An M&A deal can result in the buyer (acquirer) requesting a portion of the deal in consideration– typically 10-15%–to be held in escrow. Typically, shares of the seller or target company would be held. The escrowed shares protect the buyer from potential breaches in seller representation and warranties, covenants, contingencies, and working capital adjustments, among other material adverse items that may affect the valuation of deal or the closing itself.

For example, funds for an acquisition can be held in escrow until government regulatory authorities approve the transaction. Other times, the purchase price might need to be adjusted at some point during the process, and as a result, funds are placed in escrow to cover for the variance.

A targeted company may also request that a holdback in the form of acquirer shares be held in escrow to protect against non-performance by the acquirer in a business combination. However, the holdback can be in the form of escrow shares, cash, or a combination of both. Also, the practice of placing shares in escrow for a specified period as parties work to close the deal is common for non-public companies as well as public ones.

Bankruptcy or Reorganization

A bankruptcy or reorganization during which a company's shares are suspended from trading pending the resolution of the corporate action. In this case, a shareholder's holding will be converted to escrow shares and then converted back to their original form if any equity remains in the company after the completion of the bankruptcy or reorganization process.