What Is Earnest Money?

Molly PereiraFeatured News

By Susan Spear
From the Summer 2017 Journal of the Colorado Dental Association

Earnest money on the purchase of a practice shows the buyer’s good faith interest in the property.

Why is there an “earnest deposit” required when purchasing a dental practice? To answer that question, it is best to understand what an earnest deposit is and its value. West’s Encyclopedia of American Law defines earnest money as, “A sum of money paid by a buyer at the time of entering a contract to indicate the intention and ability of the buyer to carry out the contract. Normally such earnest money is applied against the purchase price. Often the contract provides forfeiture of this sum if the buyer defaults. A deposit of part payment of purchase price on the sale to be consummated in the future.”

When we apply the process of giving a seller an earnest deposit to purchase a dental practice, the buyer is sending the message to the seller that he/she is showing “good faith” that the purchase will reach fruition. Legallaw.com says good faith is an “honest intent to act without taking an unfair advantage over another person or to fulfill a promise to act, even when some legal technicality is not fulfilled.” Further legal definition defines it as, “honesty; a sincere intention to deal fairly with others. Good faith is an abstract and comprehensive term that encompasses a sincere belief or motive without any malice or the desire to defraud others. It derives from the translation of the Latin term bona fide, and courts use the two terms interchangeably.”

In the majority of business sales, an earnest deposit accompanies a Letter of Intent (LOI) to purchase. As the sale and purchase progress, the seller’s exposure increases and the purchaser’s commitment and obligations to demonstrate the good faith of the relationship also increases. The purchaser continues to pursue and meet contingencies, which will allow the sale to go forward.

One of the contingencies is a brief period of further exploration of the business known as “due diligence.” Due diligence should not be confused with an intent to learn as much as possible about a business and then walk away, but as further demonstration of the seriousness of the buyer. It also establishes an effort of good faith or honest presentation of information by the seller, which has been presented through initial documentation. Once this contingency is fulfilled, the buyer moves toward ownership. The earnest deposit will be applied to the purchase price.

Buying a dental practice should be taken seriously. When a buyer gives a seller an earnest deposit, the buyer is saying he/she has honest intent to purchase the business. If the buyer finds there is a true reason why he/she cannot move forward with the sale and that decision is within a period where the earnest money is still refundable, then the buyer will receive the earnest deposit back. However, if the buyer moves through the contingencies or misses deadlines and commitments that were made, the earnest deposit is no longer refundable. The buyer is in default under the good faith agreement of the parties.

Each opportunity that a seller brings to the marketplace should be approached with an understanding of what matters to both parties. The seller of a dental practice is not just transferring “tangible assets” such as equipment, but more importantly the seller is transferring “goodwill assets.” Goodwill is extremely valuable to a buyer because it is the reputation and endorsement of the practitioner. This is a big responsibility. When buying a dental practice, the earnest deposit is a demonstration of commitment and trust, thus reinforcing the goodwill value for the future.

About the Author: Susan Spear is the licensed broker/business intermediary with SAS Transitions Dental Practice Brokers. Contact her at 303-973-2147, susan@sastransitions.com or visit sastransitions.com.