When selling a childcare business, as part of the Asset Purchase Agreement (the business sale contract), the business buyer may request that a portion of the childcare business seller’s proceeds from the sale be held, usually in an escrow account, for a specified period after the transaction closes.
The buyers’ requests for a funds holdback usually ensure that the seller’s representations are accurate and that the seller adheres to the warranties provided in the APA (Asset Purchase Agreement). One way to view holdbacks is to consider them as insurance for the buyer, in case there are undiscovered problems with the childcare business after closing or if the seller fails to keep their promises.
When Are Holdbacks Appropriate?
Should the childcare business have a history of problems—licensing violations, lawsuits, public funds utilization audit discrepancies, or issues, particularly if the sale is one of stock rather than an asset sale, a holdback of funds may be appropriate to protect the business buyer. However, transferring the childcare business under an asset sale may mitigate many future problems for the buyer and eliminate the need for holdbacks.
When Are Holdbacks Not Appropriate?
Some buyers always request a certain percentage of the purchase price as a holdback in their letter of intent (LOI). Since the LOI is often submitted before due diligence, requiring holdbacks is premature. The findings of due diligence should be known before agreeing to holdbacks.
Holdbacks are not a replacement for due diligence. The buyer is responsible for thoroughly completing due diligence. “Blanket holdbacks” should not be used for the buyer to access after closing, should they discover something that could have been discovered during due diligence. For instance, buyers seek a quick closing and request that tens of thousands of dollars be held back in case they have missed something during their rush to complete due diligence and close the transaction. From the childcare seller’s standpoint, it would be better not to agree to the buyers’ rushed due diligence period and quick closing and reject the holdback request.
Another common reason childcare business buyers request holdbacks is the state licensing process for childcare, which may occur after the transaction closes, depending on the state. Buyers are concerned that to relicense the childcare business, the state licensing agency may require expensive repairs and changes to facilities—fencing, play structures, kitchen appliances, parking, security, fire protection, etc. A simple way to address these concerns is to complete all local and state licensing inspections before closing. In some states, additional fees may apply for these inspections. In some states, inspections may need to be completed again after closing as part of the state’s required licensing process. If the childcare business buyer is unfamiliar with the specific state licensing requirements, they should hire an outside consultant with knowledge of these requirements to assist with due diligence and potential state childcare licensing requirements.
Holdbacks Guidelines
- Though buyers and some business brokers may say “holdbacks are common” in childcare business sales, holdbacks are not a part of every transaction.
- An experienced childcare business broker can help eliminate the need for or reduce the amount of holdback necessary.
- An experienced childcare Mergers and Acquisitions attorney can ensure that the reason for the holdback is well-defined and that the buyer is entitled to the holdback funds under what circumstances.
- Holdbacks should be reasonable and aligned with specific potential post-closing issues, not just a “pot of money” that can be accessed for any or no reason by the buyer at the buyer’s sole discretion.
- Holdbacks should be aligned with the seller’s warranties to help minimize the seller’s exposure to financial liability above the agreed holdback amount.
