An earnest money deposit (EMD) is a buyer's good-faith payment made at the time of signing a purchase agreement — typically 1-5% of the deal price — held in escrow until closing, at which point it applies toward the purchase price or is forfeited if the buyer defaults without cause. The IRS treats EMD forfeitures as ordinary income to the seller (IRS Publication 544, https://www.irs.gov/publications/p544).
An earnest money deposit signals a buyer's serious intent to complete a transaction and creates a financial disincentive to walk away without cause. It is widely used in both real estate and business acquisitions. Once a letter of intent (LOI) is executed and the buyer has completed initial diligence, the EMD is wired to a neutral escrow agent (often a title company, attorney, or escrow service) per escrow instructions agreed by both parties. Disposition at closing vs. default: If the deal closes, the EMD applies toward the purchase price — it is not an additional payment. If the buyer terminates the deal for a reason permitted by a contingency (financing contingency, diligence contingency, material adverse change), the EMD is typically returned in full. If the buyer defaults without cause, the seller retains the EMD as liquidated damages. If the seller defaults, the buyer typically receives the EMD back plus may pursue additional remedies. SBA 7(a) acquisitions: SBA lenders frequently require the buyer to demonstrate that the EMD was paid from buyer equity (not borrowed funds), as it is considered part of the equity injection requirement. The SBA SOP 50 10 7.1 states that all equity contributions must come from sources acceptable to the lender and must not be borrowed (https://www.sba.gov/document/support-sba-standard-operating-procedures-sop-50-10). An EMD paid via personal credit card advance or bridge loan may disqualify the injection. Tax treatment: Per IRS Publication 544 (Sales and Other Dispositions of Assets, https://www.irs.gov/publications/p544), a forfeited EMD received by the seller is taxable as ordinary income in the year received. A buyer who forfeits an EMD on a business acquisition may deduct it as an ordinary loss under IRC § 165.
No. Under SBA SOP 50 10, the equity injection required for a 7(a) acquisition loan must come from the buyer's own funds — not borrowed money. An EMD drawn from a personal line of credit, credit card advance, or bridge loan will not qualify as the equity injection. Lenders verify source of funds for the EMD; using borrowed funds can result in loan denial or require a larger overall equity injection to compensate.
For business acquisitions, EMDs typically range from 1-5% of the purchase price, negotiated between buyer and seller. A higher EMD signals stronger buyer commitment and may help win a competitive deal; a lower EMD reduces downside risk for the buyer. Real estate transactions in competitive markets sometimes see EMDs of 3-10%. The 'right' amount depends on deal competition, deal size, and the nature of contingencies the buyer needs.
Standard purchase agreements include financing contingencies (buyer can exit if they cannot secure financing on agreed terms), due diligence contingencies (buyer can exit if diligence reveals material issues), and sometimes material adverse change clauses (buyer can exit if the business suffers a significant negative event before closing). Each contingency must be clearly defined with an exercise deadline; a buyer who misses a contingency deadline may lose EMD protection even if a legitimate issue arises.