Escrow account

An open offer is a promise made in public to thousands of shareholders: tender your shares and I will pay you. The escrow account is what makes the promise collectable. Before the acquirer is allowed to make the detailed public statement, it has to put security for its own performance somewhere the manager to the open offer controls.

The rule is deliberately placed early in the timetable. The escrow must be created at least two working days prior to the date of the detailed public statement of the open offer — before the market is told anything, not after.

Note that the same word is used elsewhere in this paper for different accounts: a public issue has an escrow agreement with the bankers to the offer, and a share escrow account with the registrar into which selling shareholders transfer their offered shares before the red herring prospectus is filed. This entry is the SAST one — the takeover escrow.

How much. A two-slab scale on the consideration payable under the open offer:

Where the open offer is made conditional upon a minimum level of acceptance, the deposit is 100% of the consideration payable in respect of that minimum level of acceptance, or 50% of the consideration payable under the open offer, whichever is higher — and that amount must be in cash.

On a revision. If the offer price or offer size is revised upwards, the escrow is recomputed on the revised consideration and the additional amount must be brought in before the revision is effected.

In what form. Three permitted forms: cash deposited with a scheduled commercial bank; a bank guarantee issued in favour of the manager to the open offer by a scheduled commercial bank; or a deposit of frequently traded and freely transferable equity shares or other freely transferable securities with appropriate margin. Securities are not permitted for indirect acquisitions where the public announcement is made under regulation 13(2)(e).

The cash floor. Where the escrow is created by bank guarantee or by deposit of securities, the acquirer must still keep at least 1% of the total consideration payable in cash with a scheduled commercial bank as part of the escrow.

Who controls it. On opening a cash account the acquirer must empower the manager to the open offer to instruct the bank to issue a banker's cheque or demand draft or make payment. A bank guarantee must be in favour of the manager and valid throughout the offer period and for a further thirty days after completion of payment. For a securities escrow the manager is empowered to realise the value by sale, and if there is a shortfall the manager to the open offer is liable to make it good — which is why merchant bankers dislike securities escrows.

When it is released. The manager shall not release the escrow until the expiry of thirty days from completion of payment of consideration, except for transfer to the special escrow account. Not more than 90% of the escrow may be transferred to the special escrow account. The balance returns to the acquirer after that thirty-day period, on the manager's certification. Where the acquirer fails to fulfil its SAST obligations, SEBI may direct the manager to forfeit the escrow, in full or in part, and the amount is released to the manager for distribution after deducting the expenses of registered intermediaries associated with the open offer.

Cash may earn. The cash component may be maintained in an interest-bearing account, provided the merchant banker ensures the funds are available when payment falls due.

An acquirer triggers a mandatory open offer for 26% of a target that has 20 crore equity shares in issue, at Rs 315 a share.

Shares under the open offer = 26% × 20 crore = 5.20 crore
Consideration payable       = 5.20 crore × Rs 315 = Rs 1,638 crore

The escrow, slab by slab:

That Rs 238.80 crore must be in place at least two working days before the detailed public statement. Note what the slab structure does: the blended rate is 238.80 ÷ 1,638 = 14.6%, well below 25%, because only the first Rs 500 crore attracts the higher rate. A candidate who applies 25% to the whole consideration produces Rs 409.5 crore and loses the mark.

If it is given as a bank guarantee, the acquirer must still deposit 1% of Rs 1,638 crore = Rs 16.38 crore in cash, and the guarantee must stay valid through the offer period and for thirty days after payment completes.

On an upward revision to Rs 340:

Revised consideration = 5.20 crore × Rs 340 = Rs 1,768 crore
Revised escrow        = 125 + 10% × 1,268  = Rs 251.80 crore
Additional deposit    = 251.80 − 238.80    = Rs 13.00 crore

The Rs 13 crore must be in before the revision is effected, not alongside it.

If the offer had been conditional on a minimum acceptance of 3 crore shares, the cash test would apply instead: 100% of 3 crore × Rs 315 = Rs 945 crore, against 50% of Rs 1,638 crore = Rs 819 crore — the higher is Rs 945 crore, in cash. A conditional offer is an order of magnitude more expensive to secure.

On the way out: up to 90% of Rs 238.80 crore = Rs 214.92 crore may move to the special escrow account, and nothing is released to the acquirer until thirty days after payment is completed, on the manager's certification.

Chapter 7 (Other Merchant Banking Activities – Mergers, Acquisitions & Takeovers), in the open offer process, carries the "Provision of Escrow" rules in full. The merchant banker here is the manager to the open offer, and much of the machinery — the power to operate the account, the liability for a shortfall in a securities escrow, the certification on release — is an obligation on the merchant banker personally.

Expect a slab computation as a numerical question. Expect the 1% cash rule where a bank guarantee is used, the two working days before the detailed public statement, the 30 day hold after payment and the 90% transfer cap as factual questions.

• The scale is marginal, not flat. 25% applies only to the first Rs 500 crore; 10% to everything above. Applying 25% throughout is the standard error.
• Two working days before the detailed public statement — before, not after, and not two days before the offer opens.
• A bank guarantee or securities escrow still needs 1% of the total consideration in cash. The cash floor is computed on the whole consideration, not on the escrow amount.
• A conditional offer is secured in cash on a different test entirely — the higher of 100% of the minimum acceptance consideration and 50% of the whole.
• On an upward revision the top-up goes in first. The revision cannot be effected until the escrow is made good.
• Only 90% may be transferred to the special escrow account, and the manager holds the rest for thirty days after payment completes.
• The manager to the open offer is personally liable for a shortfall in a securities escrow — a real reason merchant bankers push acquirers toward cash or a bank guarantee.
• Do not confuse it with the share escrow account in an IPO, into which selling shareholders transfer their offered shares before the red herring prospectus is filed, or with the escrow maintained for the one-year post-delisting exit offer.