How an escrow can help de-risk software investments
While the deals market is seeing activity grow, economic uncertainty means that investors are still keen to ensure they get the best value for their money on every acquisition. Andy Ramsbottom, director of global strategic accounts at Escode, explains the role the legal provisions of an escrow agreement can play in protecting venture capitalist and private equity firm’s investments.
Today’s volatile financial landscape brings numerous risks. For venture capitalists (VCs) and private equity firms (PEs), the turbulence in global markets underscores the importance of being proactive in protecting capital, particularly when investing in the tech sector. One of the most effective tools at their disposal is escrow – a legal mechanism that ensures the security and continuity of their investments.
An escrow is a legal arrangement in which a third party temporarily holds funds or assets until a particular condition has been met – such as the fulfilment of a purchase agreement. This makes it a useful safety net, helping investors to verify the assets they are investing in and ensure that their capital is being used wisely.
When to use an escrow
By leveraging escrow agreements, investors can mitigate risks associated with the software lifecycle. This includes ensuring that source code and intellectual property (IP) are securely held by an independent third party, ready to be released if certain conditions are met, such as a default by the software developer.
Escrow can be used in three ways. First, during the process of settling on single lender agreements – which can ensure that a developer's IP is securely held, and can be transferred to the lender in case of a default. This safeguard is particularly useful in scenarios where the success of the investment hinges on the continued operation and development of the software.
Second, escrow can be used during mergers and acquisitions (M&A). During M&A transactions, escrow agreements can show that the acquired code and platforms are independently verified. This also consolidates all necessary documentation, simplifying compliance with legal and regulatory requirements.
Finally, there is the due diligence process. Here, an investor and their legal counsel can use an escrow to include regular verification testing. This can help make sure software remains functional and compliant with all regulations, enabling investors to shore up their investments against future disruptions.
Planning ahead
A well-structured software escrow agreement can be the difference between a successful investment and a costly failure. By preparing early on, investors can safeguard their interests. With the assurance of a secure investment, VCs and PE firms can also focus on planning their exit strategies.
For example, when selling a software company, having an escrow agreement in place reassures acquirers that, in the event of significant disruptions, the source code and other critical assets will remain accessible. This is particularly appealing to buyers and investors who prioritise stability and continuity in their acquisitions.
