In Short
- Paying a deposit shows your commitment to buying the business and protects the seller if you withdraw.
- The standard deposit is typically 10% of the purchase price, though this can be negotiated.
- Deposits are usually paid upon signing the sale contract or heads of agreement.
Tips for Businesses
Clearly outline deposit terms in the sale agreement, including conditions for refunds and forfeiture. Ensure both parties understand when the deposit is due and under what circumstances it may be retained or returned. This clarity helps prevent disputes and facilitates a smoother transaction.
Purchasing a business is an exciting yet complex process. As a buyer, you may be expected to pay a deposit, which demonstrates your commitment to the sale and reduces the vendor’s risk in the event the deal falls over. This article explores why, how and when deposits are paid in business purchase transactions, along with essential considerations for prospective purchasers when paying a deposit.
Why Do I Need to Pay a Deposit?
A deposit serves multiple functions in a business purchase. It demonstrates that the purchaser is serious about proceeding with the acquisition and provides the seller with financial protection if the buyer withdraws from the sale. After all, the seller is agreeing to take the business off the market, meaning it would be at a disadvantage if the sale falls through. Additionally, a deposit may cover potential expenses incurred by the seller during the sale process, such as legal and accounting fees. Ultimately, a deposit creates a sense of mutual commitment and certainty for both parties.
How Much Do I Have to Pay as a Deposit?
There are no specific laws regulating the minimum or maximum amount payable as a deposit. However, a deposit equal to 10% of the total purchase price is very common. This percentage is generally considered sufficient to cover potential seller losses if the sale falls through, reasonable for the buyer to commit, and commercially acceptable in the business sale industry. A seller may, however, require a deposit that is more or less than 10% of the purchase price and ultimately, this varies on a case-by-case basis.
The deposit amount is negotiable. Factors that may influence the deposit amount include:
- the overall purchase price of the business;
- the complexity of the transaction;
- the perceived risk for both parties; and
- market conditions and industry norms.
In some cases, particularly for high-value transactions, a smaller percentage or a fixed amount might be agreed upon as 10% of the purchase price may equate to a considerable sum of money, placing the buyer at greater risk. Always consult with your legal counsel to ensure the deposit amount is fair and appropriate in your specific circumstances.
Continue reading this article below the formWhen Do I Pay the Deposit?
The timing of the deposit payment can vary depending on the structure of the deal. Generally, a deposit is paid at the same time contracts are exchanged. Sometimes, an initial deposit is required when signing the heads of agreement (also known as a term sheet or letter of intent). In some cases, you might pay a partial deposit with the heads of agreement and the balance when signing the final contracts. For complex transactions, the deposit might be paid in stages as certain milestones or conditions precedent are met. Regardless of the timing, ensure that you receive a written receipt for any deposit paid.
Issues to Consider as a Business Purchaser
1. Holding the Deposit and Refund Conditions
The deposit is typically held in a trust account by:
- the seller’s lawyer;
- a business broker; or
- an escrow service in an interest-bearing account.
This arrangement protects both parties by ensuring the funds are securely held until the sale is completed or terminated. It is important that both you and the seller are clear on the conditions attached to the deposit. For example, the purchaser should be entitled to recoup the entirety of the deposit if the sale agreement is terminated as a result of:
- a breach or default by the vendor; or
- the purchaser’s due diligence investigations being unsatisfactory, causing them to decide not to proceed with the transaction.
Similarly, you should carefully consider any terms which limit your ability to recoup the deposit. For example, sometimes, the sale contract may state that only a partial deposit can be refunded after a certain point in the sale process or that all of the deposit will be retained by the vendor. This may depend on the expenses the seller incurs up to that point in time.
2. Refund of Deposit on Failure to Transfer Lease
If the business operates on physical premises and the seller has a lease in place, the seller will likely need to obtain the landlord’s approval to transfer the lease to you, as the incoming purchaser. You may be entitled to end the contract and have the deposit returned to you in full if the seller (through no fault of yours) cannot transfer the lease to you.
Before buying a business, it is important to undertake due diligence, to verify the information supplied by the seller. This guide will walk you through the due diligence process.
3. Refund of Deposit for Termination as a result of Due Diligence Investigations
Often, sale agreements are conditional upon the buyer being satisfied with the results of any due diligence investigations in relation to the business. During the due diligence period, the purchaser typically examines materials and information and undertakes enquiries in relation to the target business in the following key areas, among others:
- operations;
- financial position;
- employment contracts;
- supplier and customer contracts;
- legal and tax compliance;
- leasing agreements;
- financing arrangements;
- financial performance and profitability;
- intellectual property;
- litigation.
It is essential to ensure that the sale agreement clarifies that your deposit is refundable in the event that you decline to proceed with a purchase following the outcome of due diligence investigations. You may, during due diligence, identify critical risks which make the transaction unviable.
4. Legal Counsel
You should always have a qualified business lawyer review the sale contract and advise on deposit terms. They can help ensure your interests are protected and the deposit arrangements are fair and legally sound.
Key Takeaways
Paying a deposit is a standard practice in business purchase transactions, demonstrating commitment and providing security for both parties. As a prospective business purchaser, it is crucial to approach the deposit process with careful consideration and thorough understanding. The deposit amount, timing and conditions are all negotiable elements of the sale agreement. As a purchaser, you should always ensure that the terms surrounding the deposit, particularly those related to refunds, are clearly defined in the sale contract and align with your interests. Above all, a qualified business lawyer can provide invaluable guidance, helping you navigate deposit arrangements and protect your interests.
If you are purchasing a business, our experienced business purchase lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Notably, no specific laws regulate how much deposit should be paid, but 10% is the industry standard.
You will usually pay the deposit when you exchange and sign the contracts of sale. However, you can sometimes pay it when you sign the heads of agreement.
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