Earnest Money in Small Business M&A

Business brokers and sellers often request earnest money in business sales.

The amounts requested vary from a small deposit of $5,000 to $10,000 to huge sums equating to 10% or more of the purchase price.In most cases, the seller and broker are requesting this either (1) to establish the seriousness of the buyer before taking the business off the market or (2) because they are inexperienced with M&A and are conflating the transaction process with real estate.

In either case, this is an important issue for buyers to address early on, as non-refundable earnest money can dramatically shift the negotiation playing field in favor of the seller.

[I'll demonstrate why in detail below.]

So how do you overcome this ask?

We usually push back in the following order:

1. Say "no" entirely

2. Say "yes" but only if the deposit is fully refundable in all circumstances

3. Say "yes" but only if the deposit is fully refundable in all circumstances other than the buyer's material breach of the agreement (e.g., the buyer walks away for no good reason).

I'll be honest, though. We get it. Sometimes sellers and brokers can be inflexible. And from time to time, we have had buyers establish other arrangements, including placing non-refundable earnest money in the name of getting a deal done.

As a buyer, that's your prerogative, and so long as we, your counsel, have fully educated you on the risks and negotiation positions, we won't stand in your way.

Buying a business is, however, very different than buying real estate. In real estate, you can inspect a property in a day or a week, and get your arms (mostly) wrapped around any issues with the target property.

Business acquisitions are very different. A business is an entity that has lived, breathed, acted, employed, contracted, etc., for, in some cases, decades.

In one prominent example, our buyers didn't discover an accounting error with the business until 90+ days into the negotiations. This error resulted in a $1.5 million purchase price adjustment!In another, we didn't discover that the seller hadn't filed taxes for over a decade until a week before closing!Imagine if in either of those situations you had a large non-refundable earnest money deposit on the line, only recoverable if you close?

Disclaimer: This post is being presented strictly for educational and informational purposes, and not for the purpose of marketing any legal services or seeking legal employment and is not motivated by pecuniary gain. Neither I nor any attorney at @smblawgroup is your attorney. Seek your own legal, financial, and other advisors.

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