Indemnification Caps, Baskets, and Escrows

Conor Meyers — Co-Founder & Business AttorneyHas built and run businesses; advises owners on contracts, transactions, and risk. About Conor →

Reps tell you what you were promised. The indemnity architecture tells you what a broken promise is worth.

A buyer with strong representations and a weak indemnity has very little. The cap, the basket, the escrow, and the survival period operate as one system, and moving any one of them changes the value of the rest. Capping seller liability is the headline term, but the basket often determines whether a claim can be brought at all.

We handle these matters for growth-stage companies in Idaho and California. This is general information — not legal or tax advice on a specific situation.

The cap is the ceiling. The basket is the door.

How caps work

A cap limits aggregate seller liability, usually expressed as a percentage of purchase price. General representation breaches commonly sit at ten to twenty percent in mid-market transactions, though the range moves with the risk profile and whether insurance is in place.

Fundamental representations, tax matters, and fraud are typically carved out and capped at the full purchase price or not capped at all. Which items sit outside the cap is frequently more consequential than the percentage.

What sits outside the cap matters more than the number.

Deductible basket vs tipping basket

A deductible basket vs tipping basket choice changes recovery substantially. With a deductible basket, once claims exceed the threshold the seller pays only the excess. With a tipping basket, once claims exceed the threshold the seller pays from the first dollar.

Buyers prefer tipping; sellers prefer deductible. The threshold itself is usually a small percentage of price, set to filter noise rather than to bar real claims.

Deductible pays the excess. Tipping pays from dollar one.

Escrow sizing and survival

Escrow holdback amount typical figures track the general cap, so a ten percent cap is often paired with an escrow near that level. The escrow matters more than the cap where the seller is an individual, because it is the only funded source of recovery.

Indemnity survival period should align with when problems surface. Twelve to twenty-four months covers one audit and operating cycle for general reps; tax and fundamental matters run longer.

For an individual seller, the escrow is the indemnity.

Making a claim

The indemnification claim process should be written plainly: notice within a stated period, description of the breach and estimated loss, a response window, and a negotiation period before escalation.

Third-party claims need their own procedure covering who controls the defense and whether settlement requires consent. A buyer that settles without consent can find it has forfeited indemnification for the amount it paid.

Settling without consent can forfeit the claim you settled.

What this means in practice

It is worth stepping back from the individual terms to look at what the package delivers. A twenty percent cap paired with a large deductible basket and a twelve-month survival period can be worth considerably less than a ten percent cap with a tipping basket and a two-year survival. Compare structures as a whole rather than negotiating each clause against a market benchmark in isolation.

The right anchor is the diligence file. If the review surfaced an unresolved tax position, a contract with a consent problem, or an employment classification question, the indemnity should be sized so those specific items are actually recoverable — which may mean a separate special indemnity outside the cap rather than a larger cap. A number set by reference to what other deals did, rather than to what this deal found, is a benchmark without a reason behind it.

Most of these problems are cheaper to prevent than to argue about.

The underlying rules on this are published directly by U.S. Small Business Administration, Internal Revenue Service, U.S. Securities and Exchange Commission, and both are worth reading before you rely on a summary of them — including this one.

A simple plan to get a legal partner in your corner

Owners who bring in business sale attorney early almost always pay less than those who call one afterward.

The engagement at a glance

A three-step path from first call to ongoing protection.

Frequently asked questions