Deposits For Business Sales
Many buyers and sellers of businesses are somewhat surprised to learn that deposits play far less of a role in business sales compared to real estate sales. In fact, deposits sometimes are not even given at all in many business deals. Business valuations may quickly change due to shifting business conditions, new competition, internal issues with the business, or when new facts or evidence are discovered by the buyer. It is thus very rare for a buyer to give a non-refundable deposit for the purchase of a business since the information they uncover about the business in due diligence (after a deposit is given) may make them change their own valuation of the business. When deposits are made, they are usually given when the deal is ‘under contract’ and is usually for 10% or so of the purchase price while held in escrow by an agreed upon third party.
Why Are Deposits Typically Refundable?
- For real estate sales, buyers typically forfeit their deposit unless they are unable to get financing.
- For business sales, deposits are normally refundable and buyers seldom lose a deposit.
- When buyers of real estate make a firm offer, they already know (or should know) the value of the property by physically observing the property and looking at nearby comparable sales.
- After receiving an inspection, a real estate buyer does not need to do any further research or due diligence on the value of the property.
- When a buyer of a business make an offer, there remains much to be scrutinized and examined by the buyer.
- A buyer’s offer is normally contingent on the buyer’s successful completion of formal due diligence (which normally starts after the buyer and seller sign some kind of a Letter of Intent).
- Examples of items to inspect during the former due diligence phase include the company’s financials, competitors, lease, and customer base.
- The discovery of new facts or evidence during this former due diligence phase frequently causes the buyer to change their valuation of the business or change their mind about buying the business at all.
- It is thus standard for business sales deposits to be refundable if formal due diligence is not successfully completed (or if another contingency such as assuming the lease on the premises is not met).
When are Deposits Usually Given?
Business sales deposits are usually made by the buyer when a Letter of Intent (LOI) is fully executed by both parties. Typically the deposit money is held by the broker or by an attorney in escrow. The Letter of Intent normally will give the buyer exclusivity (meaning the sole right to buy the business for an agreed upon period of time as described in the LOI) over the business. The deposit is the consideration given by the buyer to secure exclusivity. The seller exerts some leverage in requiring the buyer to give a deposit (even if refundable).
Benefits to Sellers of the Deposit
Before entering into a period of exclusivity with a buyer, sellers of businesses want some degree of assuredness that the buyer is serious. The act of depositing a significant amount of money (albeit refundable) in a non-interest bearing escrow account demonstrates the buyer’s seriousness. Sellers frequently need to spend a great deal of time and money to fulfill a buyer’s due diligence request list. Before incurring this time and expense, sellers particularly want to ensure that the buyer has also made the commitment of giving a refundable deposit.
When Deposits Are Non-Refundable
Although rare, it is possible that a buyer will agree to make a non-refundable deposit for the purchase of a business. Normally this will occur if there is extreme demand among buyers. A non-refundable deposit is almost never given unless all the pertinent financials of the business have been disclosed to the buyer (before a formal due diligence phase). In such a scenario, the buyer should have a high degree of certainty that no other facts or evidence could or will be discovered that would change their valuation of the business.
Some Deposits Go ‘Hard’ In Stages
For some business sales transactions, the buyer and seller may negotiate that the deposit go ‘hard’ (or non-refundable) in stages over the course of the formal due diligence period. This usually happens when there are certain steps of formal due diligence that the buyer wants to take but the seller does not want to allow unless the deposit goes hard. Both parties should be cautioned, however, that this type of transaction may lead to substantial attorney fees or disputes between the parties in reference to the deposit.
Example of Deposit Going ‘Hard’ in Stages
- Let us suppose that Bill wants to purchase a home healthcare company from Howard.
- Bill and Howard have agreed upon all major points in their Letter of Intent, but Bill wants to ensure that (prior to closing) he has the opportunity to speak to Howard’s employees and to the physicians that refer Howard his patients.
- Healthcare business sales are extremely confidential, and Howard is thus very reluctant to allow Bill access to his employees or referring physicians until after closing.
- Bill’s broker then proposes that after the completion of other aspects of formal due diligence, half of the deposit will go ‘hard’ (or non-refundable) once Bill is allowed to have discussions with the company’s employees.
- Even if Bill pulls out of the deal after speaking to the company’s employees, he will lose half of his deposit.
- Additionally, the broker proposes that the other half of the deposit will go ‘hard’ once Bill is allowed to speak to the referring physicians.
- So if Bill meets with the company’s employees and the referring physicians but decides not to close, he will lose all his deposit.
- Such proposals may be negotiated in order to best protect their confidentiality and limit the buyer’s interference with the business.
Since business sales are a ‘living’ thing, deposits are almost never non-refundable unless specifically negotiated by the parties. This is far different from real estate sales, and both buyers and sellers of businesses should be aware of the purpose and reasoning behind giving refundable business deposits.
Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.