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Realistic Earnest Money Amount To Open Escrow. Non Refundable Deposits

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Comments & Replies: 9     Views: 6404     Posted By: Willard Michlin  Willard Michlin, CPA, Due Diligence Services

Topics: Escrow Closing Issues     Tags: buying a business, deal structures, escrow bulk sales

Contributor: Business Broker, SF Bay Area

I do not believe a non-refundable deposit is appropriate until the contingencies have been removed. An initial refundable deposit of $10,000 on a $125,000 purchase price is reasonable. Once the contingencies have been removed then the deposit becoming non-refundable and also requiring an additional deposit would be appropriate. A business transaction should be fair to both Buyer and Seller. If you gave a non-refundable deposit and the Seller is unable to prove the financials to you then you will be at a disadvantage. So I wouldn't do it.

The term earnest money should be the same as a deposit. The deposit should be REFUNDABLE until certain contingencies are removed. A $10,000 deposit is reasonable but remember the amount of the deposit is negotiable. A range of $5,000-$10,000 is reasonable for a $125,000 purchase.

There is no set amount for the earnest money deposit, but standard practice is between 5-10 percent of the purchase price. I had few experiences where Seller requested that Buyer’s deposit be non-refundable. Reasons might be that there are multiple offer on the business or Seller simply wanted to secure the deal. Whatever the reason might be, buyer should only commit to this type of situation when the buyer have finished their due diligence and is fully committed to closing escrow.

The $10,000 is not necessarily excessive for a business of $125,000. However the amount can often be negotiated. I am concerned about the deposit being non refundable. Both the reason for this and the language used regarding this should be looked at by an attorney before signing. There may be a reason for it that is not explained here, but absent that I would not recommend signing until it is reviewed.

In the very least be certain to do your diligence sufficiently to know that you will not want to cancel the transaction before paying out your 10K.

I have in many articles warned against making offers, putting down deposits and opening escrow until a basic due diligence has been completed. The size of the deposit is not the issue, providing one at all until you are very sure you are going to buy the business is.

The reasons for this are many. Once you have money in escrow the seller must sign the cancellation documents to get it back, regardless of the contract terms and conditions. If the buyer unknowingly misses some deadline in the contract, the deposit could be lost. I have stories of buyers wanting to cancel deals after I had completed due diligence only to find they had unknowingly agreed to liquidated damages for not buying the business. They thought they had due diligence contingencies but they, in fact, did not. It is important to never sign any contract without a detailed review by a non-party to the agreement, such as a lawyer or due diligence expert. Lawsuits are hard and expensive to win but an ounce of prevention is very inexpensive.

There are only a very few reasons, for a buyer, to ever sign a non-refundable deposit agreement. Not one of the reasons apply until after you, your due diligence CPA and your attorney have all blessed the deal. Wanting to transfer control of the business before escrow closing is one of the most common reasons. Sharing very non-financial confidential information is another. For 99% of small businesses with no special proprietary information demanding a non- refundable deposit is a red flag that the seller and/or listing agent wants to take advantage of you.

When this is demanded before all financial information has been provided and reviewed, it is an attempt to steal your money. I can’t say that this is always the intention, but I can’t give you any other legitimate reason for demanding a non-refundable deposit. My experience has shown that this kind of seller has already had many other buyers look at the business and walked away. This is the sellers attempt to prevent it from happening again.

Liquidated damages or non-refundable deposits are usually split between the listing agent and the seller. Some unethical broker might think this is a way to make multiple commissions on one listing. Buyers beware; twenty percent of the general population would steal your pants while you are still in them. They make the other honest 80% look bad.

Contributor: Business Broker - Lliquor Stores, Markets, Hotels, N CA

Not only is it high but I feel it’s not required. Is the Seller concerned that you may back out of the deal after looking at business performance and records, in which case the $10,000 may get split between the Seller and Broker.

From Seller’s point of view he/or she may be concerned about keeping the business off the market for the duration of the contract with you or a loss of opportunity with another Buyer, or that Buyer may waste Seller’s time. However, I have never asked for a non-refundable earnest deposit from any of my clients, because contingencies can be removed as Buyer approves and accepts business records, licenses or other issues.

As long as all parties (Buyer, Seller & Broker) are serious about moving forward with the transaction, a major portion of due diligence can be completed before entering a contract, which should not take more than couple of weeks.

Every firm has their own practices, but I would only require a non-refundable deposit in the event that every last condition to the sale of the business has already been met. I.e. Buyer has reviewed and approved the books and records, there is no lease (or a lease has already been granted and effective for the date of change of possession), and all terms and conditions governing all of the closing docs etc...are reviewed and approved in writing by both Buyer and Seller. Always best to get everything in writing so there is never a disagreement or a he said / she said situation. I typically try to secure 20.0% down, so $10,000.00 is definitely acceptable, just the non-refundable part of it would make me less comfortable unless it was quite literally a "done deal".

Contributor: Business Appraisals, Valuations Advisor

No, this is not standard practice. As a business broker I never opened an escrow until both the buyer and seller had signed a purchase agreement. Theoretically all the cash you need to open an escrow is $1.00 and I never made it non refundable.. If you would open an escrow with a $10,000 non refundable deposit and the seller never signed the agreement the broker and the seller would split the $10,000????

Beware of "non-refundable earnest money" payments and non-refundable deposits. If a seller or a broker demands upfront non-refundable money, before due diligence is completed, Run, Run Fast, Run Far.

While it may be the practice in some locations or in some industries, making any "earnest money" payment that is not refundable during a due diligence period is just not prudent business practice. You wouldn’t pay an auto dealer a non-refundable fee to take a car for a test drive before buying it; nor should you pay for the opportunity to “see behind the curtain” of a business you may end up buying.

Standard - and prudent - practice is for an offer to be accompanied by a deposit check that is refundable within a certain period of time for "due diligence". My standard contract provides for the refund of a 10% deposit for "any reason or no reason” during a 10-day due diligence period. Of course, all these terms are negotiable - sometimes the deposit required may be more or less, or due diligence needs to take longer.

It's my practice to have the deposit payable directly to an independent licensed bonded escrow agent, who immediately deposits the funds. No fees are incurred drug the due diligence period, and, if the buyer cancels during that time, every penny is refunded.

If you encounter a situation in which a broker or buyer is demanding a non-refundable earnest money payment, I strongly advise consulting with an experienced transactional law attorney before signing any contract and before turning over any funds.

  Helpful Resources To Assist In Selling And Buying California Businesses
Willard Michlin, CPA, Certified Fraud Examiner, Due Diligence Services

Willard Michlin, CPA #106752, offers buyers step by step training & assistance in doing Due Diligence Services when they are thinking of making an offer, or are in process of investigating a business purchase. He helps to determine the actual net profit even when there is cash. Call 805-428-2063.

Brad Steinberg, Broker - Laundromat Specialists

PWS is the leading laundromat broker in California. Since 1968 PWS has brokered over 2,500 laundromat sales. With over 90 employees dedicated to the coin laundry industry, PWS has 18 licensed agents, a 3 person in-house finance department, 10 service technicians and a 20 person parts department.

Joe Sandbank, Esq. - Legal Services

I have provided legal counsel to business buyers, sellers and brokers for over 17 years. With prior experience as a business broker and SBA loan officer, Joe brings both a practical and legal approach to all aspects of the business acquisition process.

Helen Yoo: Escrow & Bulk Sale Services - Southern California

New Century Escrow, Inc. is a fully licensed & bonded independent escrow company. Over 20 years combined experience in handling bulk escrow transactions. Multi-lingual staff that speaks your language, including Korean, Chinese, Vietnamese. Call Helen Yoo direct at 626-890-1151.

Diane Boudreau-Tschetter: Escrow And Bulk Sale Services

California Business Escrow, Inc. is a full service independent escrow company serving all of California and has expertise in a wide range of escrows. Our team prides itself on providing an exceptional escrow experience. For more info phone Diane Boudreau-Tschetter at 888-383-3331 or 209-838-1100.

Janet Carrera - Escrow & Bulk Sale Services - SF Bay Area

Redwood Escrow Services, Inc. is a full service, licensed independent escrow company. We are EAFC Fidelity bonded, fully insured & licensed with the Department of Corporations. Committed to offering our clients the most comprehensive variety of escrow services available. Phone Janet at 510-247-0741.

Elizabeth McGovern: Escrow Services - SF Bay Area

McGovern Escrow Services, Inc., is a leading independent escrow company. We are a trusted partner with our clients, assisting them through the tangled bulk sale & liquor license transfer process. We provide attentive, quality & innovative customer service. Phone Elizabeth McGovern at 415-735-3645.

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