What is an Escrow?
An escrow is a neutral account held by a third party during the process of a transaction. It basically acts as a storage facility for all money, important documents, and instructions involved in the transaction. The third party is called the escrow agent. The escrow agent is responsible for ensuring no funds are transferred to either party until all documents are processed and all requirements of the transaction are met.
Most people are aware of escrow accounts as it relates to real estate transactions. The buyer and seller place the funds until all documents for the sale are complete and all requirements of the sale are met. Similarly, contingency based securities transactions also use escrow to ensure the terms of the offering are met before the funds and shares are transferred to the counterparties.
Platforms use escrow services help to protect investors and companies engaging in crowdfunding. Many companies need a minimum amount of capital in order to achieve their business goals. Holding investment funds in an escrow account means no investor capital will be spent by the company before the predefined funding goal amount is met. If the goal amount is not met, funds are returned to the investors, thus mitigating investment risk.
For example, imagine a security system company is raising $350,000 and the primary objective is to use the funds to expand their sales team. You, the investor, believe in their product and agree that a team to distribute their product would better position the company for success – so you invest $10,000. If the company is unsuccessful in raising funds, and only $20,000 is raised, this will not be enough to hire one full time employee – yet alone an entire sales team. However, if the funds are in escrow, your funds would be returned because the terms of the offering were not met.
Not all crowdfunding platforms make it clear whether or not escrow services are used. Be sure to be learn about the platform’s process for returning funds and closing successful offerings prior to making any investment.