Part 2 of 3: Ensuring Safe Assets While Improving M&A Escrow Investment Returns
The fundamental investment priority of an escrow is to ensure that the assets held in trust are safe and secure. Considering this primary goal and the need for immediate liquidity, escrow investments are typically not viewed as accounts that are associated with earning high yields. However, a creative and well-crafted escrow investment can contribute meaningfully to returns without sacrificing the safety of the escrow assets or the liquidity requirements.
As vehicles for the safekeeping of valuable assets, escrows are required to be secure and parties to an escrow agreement are necessarily focused on the safety and integrity of their escrow arrangements. As a result, escrow returns garner little attention and any complication with escrow deposits are avoided. For example, elevated escrow returns may be cause for concern since higher returns within the same liquidity parameters typically correlate to increased risk.
Typically, the interest offered on a cash escrow is de minimis. However, depending on the size and duration, potential escrow returns can be significantly improved. Failure to mine this source of value may undermine the full optimization of transaction economics – especially in a rising rate environment where the opportunity cost of surrendering time value increases.
One way to enhance cash escrow returns without sacrificing risk or liquidity is to purchase an escrow investment product that is managed as a pool. In such products, escrow assets are invested to meet the liquidity needs of the pool rather than the potential daily liquidity needs of each individual escrow. This works to increase yield without increasing risk because a significant portion of escrows are held until the stated term. In addition, any portion of an escrow that goes out early as a result of claims does not go out overnight since most claims allow twenty to thirty days for a response and may be subject to negotiations or dispute resolution before an amount to be released is agreed upon by the parties. If releases from the escrow are scheduled or contingent on consent from parties to the agreement, then an overnight investing discipline may put unnecessary downward pressure on rates. Increasing the weighted average life of the investment portfolio will broaden the universe of eligible assets, unlocking an opportunity for higher returns.
Finally, parties to the escrow agreement might consider the acceleration of all or a portion of the escrow interest to satisfy particular transaction costs. This would, of course, require an estimation of the available return, but capturing and directing the escrow return upfront, rather than over the life of the escrow, may be an interesting alternative for the escrow participants if available.
One should never lose sight of the fundamental objectives of an escrow arrangement – to ensure the safety of the assets held in trust and the required liquidity. Once these objectives are met, however, M&A deal participants should pay attention to the optimization and efficient delivery of returns on the escrow, which can add material value to the transaction surrounding the escrow agreement.
- View the first article in the series, “Regulatory Changes Reshape the Liquidity Landscape“
- Read the SRS Acquiom white paper, “New Regulations Will Shake Up M&A Escrow Landscape.”