Brokers Requesting Earnest Money Deposit

January 05, 2022

by a searcher from Boston College - Wallace E. Carroll School of Management in Newport, RI, USA

I've seen a few comments and posts on here buyers having a big issue with sellers/brokers requesting an earnest money deposit as part of LOI terms. Is it really not market to not have an earnest money deposit in deals like these? I come from a real estate background, so my thinking from putting myself in a seller's position is why on earth would i ever grant exclusivity and go through the headache of a real diligence process without some meaningful skin in the game from the potential buyer. Also goes a long way to show that the buyer can back up whatever claims they're making regarding their ability to actually finance the transaction. As a buyer, I would love for it not to be market, but as a future seller it's something i personally don't think i'd ever agree to. Would like to understand what I'm missing here in my thinking.

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Reply by an intermediary
from University of Wisconsin in Lawrence, KS, USA

In my 40 years of being on both the buy and sell side and now as a business intermediary in the lower middle market, I can honestly say that I have never once run across this idea of a deposit. Maybe it is because we deal in larger companies than the main street size, but it certainly is not the norm in the sector that we interact in.. One I just read talked of coming from the real estate industry, where earnest money is the norm. That might be so in that industry but selling and buying companies is not the same as selling a house. There are many more moving parts,more complexity as the deals get larger and therefore at this size, we aren't dealing with cash strapped individuals, but well funded private equity firms and strategic buyers who don't need to put a deposit down.. These types of buyers are busy and don't have time to waste issuing LOIs and conducting due diligence if they have no intention or ability to fund (exception being the Independent Sponsors sometimes). If we asked one of our private equity buyers to put down a deposit, that would be the last time they did business with us... On main street deals, which I know little about, I could see the argument for one if and only if you can't get a good feel or background on the buyer (esp individuals), of the buyer has a history of tire ticking, etc. But, I certainly would not require on as a blanket policy. We, in the M & A world accept a lot of risk when we chose to do this and one aspect is that a lot of what we do to get paid is out of our hands. We gamble on the client not changing his/her mind and leaving us high and dry but for small retainers. We risk our time and money when we drag a buyer through the sell side process and he ends up walking. There are no guarantees in this business. Requiring a deposit would have, in my opinion, the opposite effect you want in the long run.

Reply by a searcher
from Southern Methodist University in San Antonio, TX, USA

A couple thoughts. From the sell side, we recently did two transactions (one of which had an escrow). The escrow was due to very specific circumstances (bad experience with same buyer some years ago), but it did provide us with a lot of comfort granting exclusivity ( be careful on the language, without proper structuring it can be essentially useless). It all comes down to trust. Certainty of deal close plays as much into the equation as price. Walking away and eating deal costs to well funded or publicly traded companies is a part of life, but for small businesses the cash used to pay the lawyers is coming right out of the owners pocket. I think for typical search deals, as opposed to larger buyers, where the buyer and seller are on more equal footing as far as aversion to deal costs, you can probably play the card that you are just as concerned about wasting money (and time) on diligence if things don't work out as they are, and have a better case to skip the escrow.

On the buyside, I would really be sure you understand the industry and the specific business before agreeing to an escrow. You do not want to be put in a position of trying to back away because the opportunity isn't what you thought it would be and having to deal with the headache and potential litigation arising from the escrow. I think it makes much more sense for industry buyers who are intimate with the space to fork over an escrow than a generalist searcher who may change their mind for any number of reasons.

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