When someone agrees to buy a business, they usually don't hand over the full purchase price on day one. There's a period of due diligence, negotiation, and paperwork that can stretch from weeks to months.
To show the seller they're serious, buyers put down a good faith deposit, sometimes called an earnest money deposit, early in the process. It's a financial commitment that signals intent before the ink is dry on anything final.
Key Takeaways
- A good faith deposit in a business sale is typically 1% to 10% of the agreed purchase price, held in escrow until closing
- If the buyer walks away without a legitimate contractual reason, they usually forfeit the deposit
- The deposit protects sellers from time-wasters and compensates them if a deal falls through late in the process
How Much Are We Talking About?
The amount varies by deal size, industry, and how motivated both parties are to close. Here's a rough breakdown of what's common:
| Deal Size | Typical Deposit Range |
|---|---|
| Under $500,000 | 5% to 10% |
| $500K to $2M | 3% to 7% |
| $2M to $10M | 2% to 5% |
| Over $10M | 1% to 3% |
Smaller deals often require a higher percentage because the absolute dollar amount is lower and sellers need enough skin in the game to discourage casual buyers. A $200,000 business sale where the buyer only puts down $2,000 doesn't really deter anyone.
Where Does the Money Go?
It goes into escrow. A neutral third party (usually an escrow company, a business broker, or sometimes an attorney) holds the funds until the deal closes or falls apart. Neither the buyer nor seller can touch it during this period. That's the whole point.
The escrow arrangement protects both sides. The seller knows the money exists and is real. The buyer knows it won't get spent before the transaction is finalized.
What Happens If the Deal Falls Through?
This is where things get interesting, and where the purchase agreement language really matters.
If the buyer backs out for a reason covered in the contract (a due diligence contingency, a financing contingency, or a material misrepresentation by the seller), they typically get their deposit back. No harm, no foul.
If the buyer walks away with no legitimate contractual basis, the seller keeps the deposit. That's the consequence baked into the structure.
Sellers can also be at fault. If the seller pulls out, or if they misrepresented something significant about the business, the buyer is entitled to the deposit back and may have grounds for additional damages depending on the jurisdiction and contract terms.
Contingencies That Protect the Buyer
Most buyers negotiate contingencies into the purchase agreement before putting down a deposit. Common ones include:
- Due diligence contingency: Buyer can exit if the books, contracts, or operations don't check out during the review period
- Financing contingency: Deal unwinds if the buyer can't secure the funding they need
- Lease contingency: If the business depends on a specific location and the landlord won't transfer the lease, the buyer can back out
- Licensing or permit contingency: Relevant for businesses that require regulatory approval to transfer ownership
Without these clauses in writing, a buyer who gets cold feet has no clean exit.
The Negotiation Side Nobody Talks About
Sellers sometimes push for a larger deposit as leverage. A buyer who has $150,000 tied up in escrow is less likely to drag their feet or manufacture excuses to delay. From the seller's perspective, a bigger deposit also compensates them for taking the business off the market during due diligence, a period that can last 30 to 90 days.
Buyers, on the other hand, want to put down as little as possible until they've had a chance to verify everything. This is a reasonable position. Handing over a large sum before seeing the actual financial statements, customer contracts, and employee agreements is a significant risk.
The deposit amount often reflects how competitive the deal is. If multiple buyers are circling the same business, a higher deposit signals seriousness and can tip the seller's preference.
Deposit vs. Down Payment: Not the Same Thing
These terms get confused constantly. A deposit is the upfront show-of-good-faith money held in escrow before closing. A down payment is the portion of the purchase price the buyer pays directly at closing (as opposed to the financed portion).
In many deals, the deposit rolls into the down payment at closing. But until that moment, they're structurally different.
A Quick Example
Say a buyer agrees to purchase a landscaping company for $800,000. They put down a 5% good faith deposit: $40,000. That amount goes into escrow. The buyer then spends 45 days reviewing financial records, equipment, employee contracts, and customer agreements. Everything checks out. At closing, the $40,000 is credited toward the purchase price.
If the buyer had discovered during due diligence that the company's three largest contracts were about to expire and the seller knew but didn't disclose it, the buyer could have walked away with the deposit intact under the due diligence contingency.
Tax Treatment of the Deposit
The deposit itself isn't taxable income when received, because it's contingent. If the deal closes, it becomes part of the sale proceeds and gets treated accordingly. If the seller keeps a forfeited deposit, that amount is generally treated as ordinary income, not a capital gain, though the specifics depend on how the purchase agreement is structured and applicable tax law. A CPA familiar with business transactions should review this before closing.
Frequently Asked Questions
Is a good faith deposit legally required in a business sale?
No. There's no law requiring a deposit. It's a negotiated term between buyer and seller. That said, most sellers won't take a business off the market without one.
Can the deposit be paid in installments?
Yes, sometimes. Larger deals occasionally structure the deposit in two stages: an initial amount at signing of the letter of intent, and a larger second payment when the purchase agreement is executed.
Who chooses the escrow holder?
Usually the parties agree on this together. Business brokers often have established relationships with escrow companies they've used before, which can speed up the process.
What if the escrow holder goes out of business?
This is rare but worth checking. Make sure any escrow company is licensed and insured. Using an attorney's trust account is another option that adds a layer of professional accountability.
Does the seller earn interest on the deposit while it's in escrow?
That depends entirely on the escrow agreement. In some deals, interest accrues to the buyer. In others, it goes to the seller. Many smaller deals don't address it at all because the amounts involved are minor.
Can a seller demand a non-refundable deposit?
They can ask for it. Buyers should be very cautious about agreeing to a fully non-refundable deposit before completing due diligence, because it removes the safety net the contingencies are designed to provide.
Conclusion
A good faith deposit is a practical mechanism that creates accountability on both sides of a business sale before any final paperwork is signed. Get the contingency language right and use a reputable escrow holder, and it works the way it's supposed to.