Why do we take a deposit from a buyer when preparing and executing a Purchase Agreement Contract on a sale of a business?
The short, legal answer is that "without consideration a contract is unenforceable". The potential problem is that I negotiate and agree upon a price, terms and conditions to buy a business and sign an agreement with a seller but do not put up a deposit.
Tomorrow the seller changes his mind, doesn't want to sell or finds a buyer who will pay more money. The seller ignores your agreement and decides not to sell or goes on to buyer number 2 and you cannot enforce your original Purchase Agreement because there is no consideration.
How much consideration should I give as deposit?
One dollar can make it enforceable but it will only convince the seller that you as a buyer are not serious. As a broker I like to see a deposit of 5 to 10% of the purchase price. A minimum amount of $5,000 deposit with the offer. When I do open escrow I like to open with 10% of the purchase price. More on this below.
Are Deposits refundable and when?
In almost every case there are one or more contingencies in the Purchase Agreement. Until a buyers due diligence is satisfied the deposit should be refundable. Sellers need to cap the time period on due diligence and not let it drag on. After the buyer is satisfied with their due diligence I like them to sign off and remove that contingency. Thereafter deposits should not be refundable. An exception to this would be if the buyer cannot get approved by the landlord (a good broker should perform his own due diligence on the buyer and pre-qualify them).
Cashing Deposits and Opening Escrow:
I prefer to do the deal in this manner. My Purchase Agreement has buyer and seller authorizing me to hold the buyers deposit un-cashed until opening escrow. I have the buyer perform their due diligence before opening escrow. Once approved I open escrow and deposit their check with the escrow holder.
Return of Deposit to Buyer:
Once their deposit is in escrow and escrow is signed, no escrow company will release the deposit back to the buyer or forfeit it to the seller (even if it states the deposit is non-refundable) without a written cancellation instruction signed by both parties instructing the distribution of the deposit. When the market was in a frenzy a few years ago, many deals were done with a release of a pre-agreed amount of money to the seller upon opening of escrow (this cannot be done on any business with an ABC license). The early release of funds skirted the issue of signing a cancellation agreement later. It is hard to get a buyer to sign a cancellation forfeiting his money at a later time.
With all the above said; I feel it is best for all parties involved to perform due diligence, and remove all possible contingencies before opening escrow. Then once you go to escrow it is a very solid deal.
Categories: BizBen Blog Contributor, Business Broker Information, Buying A Business, Deal And Escrow Issues, How To Buy A Business, How To Sell A Business
Lee Petsas has been selling businesses with UBI Business Brokers in Southern CA since 1981. In 1999 he became the Owner and Broker for UBI. He has been approved multiple times by Courts as an Expert Witness in the area of Business Valuations.
Comments & Feedback From Pro Intermediaries & Pro Advisors On BizBen:
Posted By: Timothy Cunha JD, Business Broker: San Francisco Bay Area
As a business broker, I NEVER hold a deposit from the buyer. Instead, I use the services of a business escrow agent, to hold the deposits from the buyer as an independent, licensed, bonded, neutral party. My customary approach is for the contract to require the buyer to wire a 5%-10% deposit to the escrow agent immediately upon signing the contract, and then to wire an additional 5%-10% upon the conclusion of due diligence. The escrow agent charges nothing for holding the deposit unless and until due diligence is successfully completed and the escrow process continues.
Posted By: Joe Ranieri, Business Broker: LA, Orange Counties, California
Lee, you hit on some great points. I agree, one of the best ways to reduce the odds of a deal going sideways is to do the due diligence and prequalification of the buyer with a landlord before cashing the check and opening escrow. Although a landlord might not be able to give you full approval, a smart broker can determine if there are any things in the buyers' debts or credit report that might lead to a problem later on, and fix them before opening an escrow. I usually ask for a minimum of $10,000 to open escrow, it shows to the seller that they are serious, if a buyer wants to open escrow with $2,000-$3,000, I advise to the seller that it's too low, because someone might walk away from $2,000 if they decide they don't want to buy for non reason, but $10,000 is more harder to take a loss on.
Posted By: Timothy Cunha JD, Business Broker: San Francisco Bay Area
My process for handling good faith purchase deposits is a bit different. As the selling broker, I don't touch the money; but, instead, I use a licensed and bonded escrow agent to deposit the buyer's funds pending the conclusion of due diligence.
A while back, one of our Transworld offices in Florida received a deposit from a buyer for a substantial amount of money. It was drawn on a major bank, with a very legitimate-looking check, from an apparently legitimate account. We assume that the buyer thought the check would be held, un-cashed, during due diligence; but, as specified in writing in the contract, the escrow agent deposited it. Lo and behold, the check was bogus, the account was bogus, and the buying company was bogus! Needless to say, the fraudulent buyer spent some time as an unhappy "guest" of the State of Florida for their criminal activity.
So, I find that the only way to protect the seller from a potentially fraudulent buyer is to obtain a reasonable good faith deposit and have the escrow agent deposit it. In fact, we routinely have the offeror wire the funds to the escrow agent in order to speed up the process, because time kills deals.
Posted By: Business Broker, Northern California
Good article Lee. you've broken down the issues well. Almost without exception, the offer to buy a business includes contingencies. A buyers deposit is fully refundable until those contingencies are met and removed and so this does help a nervous buyer and can frustrate a motivated seller. It provides another reason why having a third party professional can help keep the seller and buyer heading in the right direction during their transaction.
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