Too often, corporate treasury professionals are brought to the table late in merger and acquisition (M&A) transactions. While parties to the deal are focused on tense negotiations, the treasurer may remain mostly off the radar. Then he or she may finally be brought into the loop near the end of the discussions, at which point the treasury team has insufficient time for planning the post-merger transition.

However, one key area in which treasury can plan adequately in advance and from a distance is M&A escrows. Typically relegated to the back burner in the midst of a transaction, escrows have increasingly become a point of focus among treasurers given new regulatory changes and emerging investment options.

M&A escrow accounts are formed to hold a portion of the agreed-upon purchase price in escrow as protection against certain potential losses. For example, if the selling company misrepresents some fact about its business, or if it fails to perform a required task prior to closing, the buyer could regain any losses by making a claim against the escrow account rather than filing a lawsuit against the acquired company's former shareholders. The duration of a typical M&A escrow is 12 to 24 months. In some cases, that term is extended if indemnification claims are made under the merger or acquisition agreement.

When it comes to planning for an upcoming M&A escrow, the treasury team should focus on investment vehicles that ensure liquidity, protect principal, and hopefully gain some level of return. Historically, these goals have guided most escrow dollars into money market deposit accounts and money market funds. Parties to a merger frequently chose prime money market funds to diversify their counterparty risk and, in their assessment, maximize protection against loss. After all, prime money funds generally met the criteria of the merger parties, including principal protection, liquidity when needed, and low cost and burden of administration. And although yield in money markets has been virtually nonexistent in recent history, parties to a merger usually had few alternatives, and prime money market accounts arguably provided the best yield available.

But what made sense historically makes less sense today. Regulatory changes implemented in October have made prime money market funds far less suitable for holding escrow in a merger. Floating net asset values and the possibility of liquidity fees mean that a company is no longer guaranteed access to its full principal. Although the value of prime money funds is not expected to swing dramatically, a dollar in is not necessarily a dollar out. This is a deal-breaker for most M&A escrows; corporate policy requires guarantee of principal.

For treasury professionals tasked with finding an alternative vehicle for M&A escrow, options may at first seem grim. A logical alternative to prime money market funds are government money market funds. These funds took in a shocking US$194 billion dollars during the last two weeks of September alone, and have continued growing. Their total assets are now worth over $1.6 trillion.

However, because banks do not earn much on these investment vehicles, they often charge fees to hold money in escrow in them, which can be tantamount to a negative interest rate in this low-rate environment. Banks that do not charge fees may pull back on the related services they provide, in an effort to cut expenses. Payments to shareholders, for example, are increasingly being outsourced to third parties to allow banks to preserve margins. This means merger parties that rely on banks are increasingly having to negotiate with third parties to ensure timely and efficient payouts.

Another reason the cost of delivering M&A escrow products has increased is that new “know your customer” rules require banks to perform background checks on their customers and implement more robust reporting. Pressure is building for banks to divest themselves of products that require intensive and expensive maintenance activities. M&A escrows fit that bill, so some banks have begun to outsource their escrow servicing.

Merger parties that rely on banks should ensure they are asking questions and are aware of any third parties that could impact the timing of their transaction.

New Options for M&A Escrow

New escrow solutions now coming to market might help put treasury professionals more at ease. Some companies have recently pioneered investment options designed specifically to hold escrow for parties to a merger.

A prime example of new investment options are insurance-backed escrow vehicles, which help diversify counterparty risk while providing an alternative to bank deposits and money market funds. When merger proceeds are placed into an insurance-backed investment product specifically designed for M&A escrows, the funds are invested in a portfolio of high-quality liquid securities similar to those that a money market fund would hold. Additionally, the insurance-backed products currently available over-collateralize the escrow deposit. Thus, unlike the volatility that occurs when the daily value of money market funds fluctuates, the insurer guarantees the parties will always get a return of their principal plus accrued interest. Also, in contrast to what happens in a bank deposit, where the investors are general obligors of the bank, money invested in an insurance company's separate accounts is insulated from the insurance company's other obligations. Therefore, deal parties would lose principal only if there were both a loss the separate account and a default by the insurer on its guarantee against loss.

These and other new investment vehicles provide protection against loss, while offering liquidity and yields that are attractive when compared with most money market funds.

Shifting regulations, paired with precarious market conditions, present challenges for even the best and most efficient investment vehicles. The challenge for treasury groups is to ensure their M&A transaction utilizes a product for escrow that meets their organization's investment criteria. In today's changing environment, it's more important than ever before to review all facets and terms of escrow investment alternatives, including any fees that may be charged or services that may be forfeited with certain investment elections.

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Alex Tsarnas, CTP, is the managing director of global business development for SRS Acquiom, which offers a full suite of closing and post-closing solutions for M&A transactions, including escrow, transactional risk, payments administration, and shareholder representation. Prior to SRS Acquiom, he served as a managing director at BNY Mellon, where he was responsible for corporate, insurance, and financial institution relationships within the corporate trust business. Alex is a graduate of Fordham University. To learn more about SRS Acquiom, visit srsacquiom.com.

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