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What Is Escrow, and Why Should a Small Business Owner Know About It?

Transactions between two parties can be tricky business. As a small business owner, you need to make sure that things like selling tangible and intangible assets goes smoothly. You might consider using an escrow agent to help. So, what is escrow?

What is escrow?

Escrow is the safekeeping of monetary items by a neutral party. Two parties, an issuer and receiver, use an escrow service to keep money, property deeds, securities, bonds, or other types of assets until the transaction is safely completed. Certain terms and conditions must be met for the release of funds.

The neutral party is known as an escrow agent or officer. An escrow agent can either be an individual, like an attorney, or an institution, like a bank.

You might think an escrow sounds a lot like a trust and an escrow officer like a trustee. However, a trustee is not neutral—they work for the beneficiary. An escrow agent is neutral, and works for both the issuer and the receiver.

What is an escrow account used for?

Escrows can be used for sales and loan agreements. In a sales agreement, the two parties are called buyers and sellers. In a loan agreement, the parties are called lenders and lendees.

As a small business owner, you might use a business escrow account to transfer assets to a buyer, or vice versa. And, a lender could use an escrow to transfer a business loan to you.

You can use an escrow bank account to deposit funds to pay the loan amount and interest in installments.

How does escrow work?

The issuing party transfers ownership of the item to the receiving party. The neutral party holds and then transfers the items once the parties reach the escrow requirements.

The parties decide terms and conditions for accessing the deposit. These terms decide what needs to happen before the transaction can be completed. The neutral, third party (the escrow agent) does not advance the transaction until the parties reach the agreement.

Using an escrow ensures that the transaction is fair and benefits both the buyer and seller in relation to their agreement.

what is escrow

Types of escrow accounts

Before opening an escrow account for just any transaction, take a look at some of the reasons you might consider escrow.

Real estate

Escrow is commonly associated with real estate. If you buy a house or piece of property, you will probably place funds in escrow instead of directly handing the money to the seller.

For example, you want to buy a new building for your business. You expect the seller to renovate some parts. And, you require the seller to hire an inspector before purchase. The seller wants to make sure that you will purchase and pay them if these agreements are met. You can put your deposit in escrow.

Selling/buying assets

As a business owner, you might want to sell off some of your assets from time to time. Or, you might want to purchase assets. To make sure the transaction goes well, you can use an escrow. This is especially important in online property transactions because it legitimizes the process.

Let’s say that you are selling a piece of company equipment for $5,000. You want to make sure that the seller will pay you as soon as they receive the item. And, the seller wants to make sure the equipment arrives before they pay you. You can use an escrow to carry out the transaction so it benefits both you and the buyer.

Stocks

Stocks are also frequently put in escrow. If you are a shareholder, you might receive your stocks in escrow. This guarantees that you won’t get rid of your stock until you meet certain terms. You can also issue stocks in your company in escrow.

How to open an escrow account

First and foremost, it’s important to use an escrow agent that you trust. When setting up an escrow account, you need to do the following:

  1. Come to an agreement with the other party on the terms and conditions of the escrow account.
  2. Gather documents indicating the specifics of the contract. Include contact information for both the issuer and receiver, as well as details about the price, loan or asset terms, how much money the escrow will hold onto, tax payments, repairs and renovations, and more.
  3. Assign an escrow officer, or agree that the other party will assign an escrow officer.
  4. Give all information to the escrow agent and sign documents indicating both your and the other party’s consent.

There might also be escrow laws by state, so make sure to read up on your requirements.

Once you are done opening an escrow, the escrow agent will be in charge of handling disputes and other legal requirements. The escrow agent drafts up documentation that both parties are required to sign throughout the transaction. These documents indicate that each party is fulfilling their legal obligations.

If the agreement is successful, the escrow officer closes the escrow. They transfer funds and property to the respective parties and finalize documents. Again, you and the other party will need to sign off on everything.

If the deal falls through, the escrow agent will return properties and monies to the original parties.

You need to track escrow and other business accounts to keep your accounting books up to date. Patriot’s online accounting software lets you easily track your money. Get your free trial now!

This article has been updated from its original publish date of 09/19/2015.

This is not intended as legal advice; for more information, please click here.

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