Deposits for Business Sales Typically Refundable
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 for some business sale transactions. Businesses should be viewed as a ‘living thing’ where its valuation may significantly 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. Nevertheless, both buyers and sellers of South Florida businesses should be cognizant of when and how deposits are normally made.
Why Are Business Sales 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 itself as well as its location.
- 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 thus normally contingent on the buyer’s successful completion of former 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, employees, competitors, lease, and suppliers.
- 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 to the buyer if the due diligence is not successfully completed (or if another contingency such as assuming the lease on the premises is not met).
When are Business Sales 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 the agreed upon period of time as described in the LOI) over the business. The deposit is the instrument by which this exclusivity is signified as a tangible step taken by the buyer in order to gain such exclusivity.
Benefits to Business Sellers of the Deposit
Sellers of businesses want some degree of assuredness that the buyer is a serious buyer. 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 see that the buyer also incurs the time, hassle, and (temporary) expense of making a refundable deposit.
When Business Sales 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 for the purchase of the business, and virtually all the financials of the business have already been disclosed to the buyer (before a formal due diligence phase). In such a scenario, the buyer must also have some assuredness that no other facts or evidence could or will be discovered that would change their valuation of the business.
Some Business Sales Deposits May 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 due diligence phase up until closing. This usually happens when there are certain steps of 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 attorney fees can be very expensive and it is usually best for the parties to negotiate and avoid having business sales deposits go hard in stages.
Example of South Florida Business Sales Deposit Going ‘Hard’ in Stages
- Let us suppose that Bill wants to purchase Howard’s Home Healthcare Company.
- Bill and Howard have agreed upon all major points in their Letter of Intent, but Bill wants to ensure that 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 thus proposes that after the completion of regular due diligence, half of his deposit (which is for 10 percent of the purchase price) will go ‘hard’ (or non-refundable) once he 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, Bill proposes that the other half of his deposit will go ‘hard’ once he 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 by the seller (with the assistance of the professional business broker) in order to best protect their confidentiality and limit the buyer’s interference with the business.
Since business sales are a ‘living’ thing, business sale 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.