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Due Diligence Checklist for Selling a Sole Proprietorship



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A Few Key Points on the Sole Proprietor Due Diligence Checklist

Douglas Bean
by Douglas Bean, J.D.

The Due Diligence Checklist for the sale of a sole proprietorship or partnership serves two purposes:

  • To provide a list of possible terms and conditions the Seller (or Buyer) may want to consider for inclusion in the definitive Business Sale Agreement. The list provides a variety of "optional" clauses designed to provide flexibility while creating a framework that helps the user understand the documents they should begin collecting and preparing to exchange during due diligence.
  • The second purpose of the checklist is to show the types of documentation the Seller (or Buyer) should begin preparing for review by the opposing parties.

Due Diligence can be a stressful part of the selling process. A Seller may feel they are sharing "all their secrets" to a potential competitor. It’s natural to feel this way, but the due diligence process is a necessary step to agreeing to the final terms of a deal. The Letter of Intent, as well as the Business Sale Agreement, provide confidentiality clauses to protect the Seller’s privacy.

Related: What Information is needed for Due Diligence

Typically, documents assembled for review by the other party are gathered, indexed, and then provided to the party reviewing the documents in a secure location where copies may be made, but physical documents may not be removed. This can be a secure conference room inside the business, or some other location where both parties feel comfortable.

The goal of due diligence is three-fold: 1) It is a time period during which both parties verify (by reviewing documents and other reports) that the proposed terms of the sale agreement are acceptable. 2) Any potential risk, downside, or problems are identified and can be factored into the final agreement. 3) Each party become comfortable with the past operation of the business as well as future interaction by the parties and that a successful transaction is likely.

Finally, because the due diligence period is costly and involves risk, it should be well organized and quick. That means preparing the relevant documents with accuracy and speed, as well as informing third parties about your need for certain documents (lawyers, accountants, banks, etc.), should happen quickly. Serious purchasers should be prepared to devote substantial resources to the review of the Seller’s documents so the due diligence process proceeds efficiently and promptly.

View all forms and template documents to selling a business.


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Due Diligence Checklist-Worksheet

The following information and terms will be incorporated into a Business Sale Agreement to be signed by the parties. It is important to consider each set of example terms and decide whether or not you feel they should be incorporated into the final sale agreement. A formal Letter of Intent should be signed before any due diligence takes place by either party.

Included in the worksheet-checklist are also lists of documents, reports, and other documentation you should prepare for the other party to review. Without these documents, the Buyer (or Seller) cannot adequately evaluate the sale as a whole.

1. SELLER INFORMATION:

2. BUYER INFORMATION:

3. NAME OF BUSINESS TO BE SOLD

Trade Name _____________________________________________

Address ________________________________________________

_________________________________, ______ __________

Phone ____________________

Type: Sole Proprietorship / Partnership

Primary Product/Service: __________________________________________

Primary Location(s): ______________________________________________

4. ASSETS

Consider documenting the following types of assets for the Buyer.

  • Cash. Cash and cash accounts, including
  • Real Estate. All of the real property and improvements
  • Accounts Receivable. All of Seller's accounts receivable
  • Equipment. All rolling stock, machinery, equipment, vehicles (licensed and not licensed), office equipment, computer hardware and software, tools, supplies, parts, furniture, fixtures, and all other assets of a similar character owned by Seller and used in the business.
  • Inventory. All inventory held as of the closing date.
  • Contracts. All of Seller's contracts
  • Miscellaneous Assets. Consider documenting the following assets:
    • [  ] telephone numbers and telephone directory listings and advertising
    • [  ] customer lists
    • [  ] sales and purchase records
    • [  ] office records
    • [  ] all drawings
    • [  ] franchises
    • [  ] licenses, permits, other rights granted by governmental agencies
    • [  ] trademarks, trade names, logos
    • [  ] copyrights
    • [  ] patents
    • [  ] goodwill
    • [  ] know-how, processes
    • [  ] supplies
    • [  ] other: _____________________________

    Documents to prepare for Due Diligence:

    1. List of Cash Accounts
    2. Descriptions of all Real Property
    3. Reports of all accounts receivable
    4. Lists of equipment with asset IDs (if available)
    5. Reports of Inventory
    6. Lists of contracts
    7. Documentation for any other assets (e.g. Trademarks, patents, software code, etc.)

5. CLOSING INVENTORIES

Consider preparing documents and reports for the following:

  • The value of Seller's inventory
  • Reports of existing inventory

6. ACCOUNTS RECEIVABLE

Consider preparing reports for the following:

  • List and outstanding amounts for accounts receivable.

  • Optional paragraphs to consider for the Business Sale Agreement regarding collection of Account Receivable:

    • [  ] Seller will collect and retain Seller's accounts receivable.
    • [  ] Buyer will collect Seller's accounts receivable and remit them to Seller.
    • [  ] Buyer will collect and retain Seller's accounts receivable.

Documents to prepare for Due Diligence:

  1. Accounts receivable report
  2. Banking documents (monthly statements, lines of credit, debt obligations, etc.)

7. ENVIRONMENTAL

Will there be any environmental reports required before the Sale? If so, consider these optional paragraphs:

[  ] Audit:

  • [   ] Seller will arrange for a Phase I environmental audit of the real estate
  • [   ] Buyer will arrange for a Phase I environmental audit of the real estate
  • [   ] at Seller's expense.
  • [   ] at Buyer's expense.

[  ] If the audit or other reports indicate that the real estate may be contaminated with a hazardous substance

  • [  ] and if the cost of testing and/or cleanup is reasonably expected to be less than _____% of the purchase price of the assets, Seller will pay for the testing and cleanup and the parties will proceed to close.
  • [  ] If the cost is reasonably expected to be more than that, Seller may terminate the Business Sale Agreement.

[  ] Seller will be responsible for all obligations regarding environmental reporting to applicable governmental agencies.

[  ] Seller will indemnify Buyer for obligations arising out of environmental contamination which exists before the closing (even if not discovered or actionable until some later date).

  • [  ] but only to the extent that such obligations exceed $ ______ in the aggregate.
  • [  ] but only if acted upon by an applicable governmental agency within _____ years after the closing.

[  ] Buyer will indemnify Seller for all obligations arising out of environmental contamination which originate after the closing date.

Possible documents to prepare for Due Diligence:

  1. Environmental reports that may be required
  2. Prior environmental reports or disclosures
  3. Reports listing possible environmental issues

8. EMPLOYEES

Consider the following optional paragraph regarding employees:

  • [  ] Seller will pay any wages, severance pay, and benefits, accrued through the date of the closing.
  • [  ] Seller will indemnify Buyer against all employee obligations arising prior to the closing date.

Possible documents to prepare for Due Diligence:

  1. Form or template employee agreements in use
  2. Actual employee, or independent contractor, agreements
  3. Reports listing past wage-related audits and resolution (Department of Labor, etc.)
  4. Potential or actual employee disputes
  5. Existing employee non-compete agreements

9. CONSULTING AGREEMENT

If the Seller wishes to be employed after the Sale a consulting agreement may be appropriate. Consider using the following paragraphs:

Buyer

  • [  ] and Seller
  • [  ] and ____________________________________(name of key employee(s))

("Consultant") will enter into a consulting agreement, providing for transition-period consulting for a period of ___________ (term).

  • [  ] with a minimum of ______ hours per week.

  • [  ] Compensation:

    • [  ] Consultant's compensation is included in the purchase price described above in paragraph 3.
    • [  ] Consultant is to be compensated at a rate of $ ______ per _________.
  • [  ] Consultant will provide the following assistance to Buyer during the term of the consulting agreement: ___________________________________________________

10. TAXES

Seller will be responsible for the payment of all taxes which are payable in connection with the sale of assets.

Possible documents to prepare for Due Diligence:

  1. Prior year tax returns (state and federal)
  2. Reports listing the occurrence and outcome of prior year tax audits
  3. Reports listing any tax arrearages or disputes
  4. Reports listing the existence of any tax liens on real property or assets

11. BULK SALES LAW COMPLIANCE

Seller will furnish to Buyer a complete list of existing creditors, with the amounts due to each, and agrees to cooperate with Buyer in all matters related to notice to such creditors in accordance with the provisions of the Uniform Commercial Code.

Possible documents to prepare for Due Diligence:

  1. List of creditors with amounts owning
  2. Reports listing prior disputes (including resolution) with current or past creditors
  3. Copies of any credit agreements (leases, mortgages, financing documents, etc.)

12. ANNOUNCEMENTS

The parties will cooperate with each other in announcing this transaction. Depending on the nature of the business, consider using the following paragraphs to tailor how notice will be provided to key individuals.

[  ] Seller will cooperate with Buyer in notifying key customers and vendors.

  • [  ] in person.
  • [  ] through written correspondence.

13. ITEMS TO BE DELIVERED BY SELLER AT CLOSING

At the closing, Seller will perform all acts necessary to put Buyer in actual and complete possession and ownership of the assets, free of all liens. Consider gathering the following documents:

[  ] Deed for the real estate and any necessary accompanying documents.

[  ] Bill of Sale for the

  • [  ] equipment.
  • [  ] inventory.
  • [  ] miscellaneous assets.

[  ] Assignment of

  • [  ] patents.
  • [  ] trademarks.
  • [  ] trade names.
  • [  ] copyrights.
  • [  ] contracts.
  • [  ] leases.

[  ] Assignment of motor vehicle titles.

[  ] All certificates of occupancy, licenses, tariffs, permits, authorizations, approvals and applications, required by law or issued by any government authority having jurisdiction over the assets.

[  ] Releases of all liens.

[  ] Consents of any third parties necessary to permit the sale.

[  ] Consents of any third parties necessary to assign the contracts to Buyer.

[  ] Evidence that all necessary corporate proceedings of Seller have been taken to authorize the transaction.

Possible documents to prepare for Due Diligence:

  1. Deeds to any real estate
  2. Titles (Motor vehicles, etc.)
  3. Leases (equipment and/or commercial property)

14. ITEMS TO BE DELIVERED BY BUYER AT CLOSING.

Consider using the following paragraphs regarding items the Buyer will deliver at closing:

[  ] Evidence that all necessary authorizations have been obtained from Buyer's governing body.

[  ] including a corporate resolution authorizing Buyer's purchase of the assets.

[  ] Buyer's attorney's opinion letter.

[  ] Employment agreement for __________________________________

[  ] Consulting agreement for ____________________________________

Possible documents to prepare for Due Diligence:

  1. Draft employee / consulting agreements

15. CONDITIONS PRECEDENT TO BUYER'S OBLIGATIONS

Consider using the following paragraphs to obligate the Buyer to certain conditions at closing:

[  ] Buyer will have obtained financing for the proposed purchase

    • [  ] on terms reasonably satisfactory to Buyer.
    • [  ] providing for a loan for not less than _____% of the purchase price, repayment over a term not less than _____ years, and at an interest rate not greater than _____%.
  • [  ] Buyer will upon execution of the Business Sale Agreement immediately make application for such financing and use its best efforts to obtain it.
  • [  ] Buyer will satisfy or release such financing conditions by ____________.
    [   ] and if Buyer fails to release such financing conditions by that date, Seller has the option to cancel the Business Sale Agreement.

[  ] Buyer will have obtained inspection results, to its reasonable satisfaction, regarding:

  • [  ] the structural, mechanical, plumbing, or electrical components of the building.
  • [  ] pest damage to the building.
  • [  ] unsafe conditions or damage to the premises.
  • [  ] the presence of radon gas or lead-based paint hazards.
  • [  ] other conditions, the inspection of which is customary to the locality and/or required by law.
  • [  ] the condition of the assets.

[  ] Copies of all pertinent documents and records have been available to Buyer for inspection.

[  ] Buyer has not discovered any material error, misstatement or omission in the representations and warranties made by Seller.

[  ] The representations and warranties of Seller continue to be true and correct.

[  ] Seller has performed all terms and conditions of the Business Sale Agreement.

[  ] Buyer has received the items to be delivered at the closing by Seller.

[  ] Between the date of the Business Sale Agreement and the closing date, there have not been any materially adverse changes in the assets or the business.

[  ] No legal proceeding has been instituted or threatened which materially affects the assets or the business or which may interfere with the closing.

[  ] Buyer has obtained all necessary or appropriate licenses, permits and governmental approvals to enable it to acquire the assets and operate the business.

[  ] Buyer will use its best efforts to obtain such items.

[  ] Seller and Buyer have obtained all consents of any third parties necessary to permit the closing.
[  ] including the consent of the landlord to assign the premises lease to Buyer.

[  ] The real estate is not contaminated by any hazardous substances, proven to Buyer's reasonable satisfaction.
[  ] in compliance with the environmental provisions contained in the Business Sale Agreement (described above in paragraph 8).

16. CONDITIONS PRECEDENT TO SELLER'S OBLIGATIONS

Consider using the following paragraphs to obligate the Buyer to certain conditions at closing:

[  ] Seller has not discovered a material error, misstatement or omission in the representations or warranties made by Buyer.

[  ] Buyer has performed all terms and conditions of the Business Sale Agreement.

[  ] Seller has received the items to be delivered at closing by Buyer.

17. REPRESENTATIONS OF SELLER

Consider using the following paragraphs such that Seller represents and warrants to Buyer the following:

[  ] Seller is in good standing, and operates with all necessary authority.

[  ] The Business Sale Agreement is legally binding against Seller.

[  ] The execution and performance of the Business Sale Agreement will not violate any of Seller's agreements, including loans.

[  ] There is no legal claim pending or threatened against Seller which might have an adverse effect on the assets, the business, or this transaction.

[  ] True and complete copies of all contracts, leases, agreements, licenses and permits relating to the operation of the business or the assets have been provided to Buyer by Seller. Seller and the other parties to the agreements are not in default under any of the agreements. The execution and performance of the Business Sale Agreement will not constitute a default under any of the agreements.

[  ] A true and complete list of all of Seller's employees, and their pertinent history with Seller, has been provided to Buyer.

[  ] At the closing, Seller will transfer good and marketable title to the assets.

[  ] All of the tangible assets are in good working order.

[  ] The assets and the business operations are insured for adequate amounts under valid liability and casualty policies.

[  ] The real estate is not contaminated with any hazardous substances.
[  ] to the best of Seller's knowledge.

[  ] Seller is not in violation of any requirements of any environmental law with respect to the operation of the business or the assets.
[  ] to the best of Seller's knowledge.

[  ] Seller has timely filed all federal, state and local tax returns and has paid all applicable taxes and assessments which have become due and payable.

[  ] Seller has provided Buyer with accurate financial statements which fairly represent the business.

[  ] No statement, representation or warranty by Seller in the Business Sale Agreement or in any document delivered in connection with this sale contains any untrue or misleading statement of material fact. There is no information which would have a material adverse effect on the assets or the business which has not been disclosed to Buyer in writing.

[  ] Seller has not participated in any retirement plan for the benefit of any employees of the business.

[  ] Seller will change its name after the closing and take all necessary steps to transfer to Buyer the name used in connection with the business.

[ ] Seller has held all necessary licenses and permits to conduct the business.

Possible documents to prepare for Due Diligence:

  1. Contracts, leases, agreements, licenses and permits relating to the operation of the business.
  2. Insurance policies

18. REPRESENTATIONS OF BUYER.

Consider using the following paragraphs such that Buyer represents and warrants to Seller the following:

[  ] Buyer is validly organized, and in good standing.

[  ] The Business Sale Agreement is legally binding against Buyer.

[  ] The execution and performance of the Business Sale Agreement will not violate Buyer's organizational documents.

[  ] There is no legal claim pending or threatened against Buyer which might have an adverse effect on this transaction.

19. NEGATIVE COVENANTS OF SELLER PENDING CLOSING.

Consider using the following paragraphs such that from the date of the Business Sale Agreement and until the closing, with respect to the assets and the operation of the business, Seller will not:

  • [  ] Incur any obligations except in the ordinary course of business.
  • [  ] Allow any additional liens on the assets.
  • [  ] Sell any of the assets,
        [ ] except sales of inventory in the ordinary course of business.
  • [  ] Amend, transfer or terminate any of the contracts to be assumed by Buyer.
  • [  ] Grant salary or benefit increases to employees.
  • [  ] Enter into any transactions other than in the ordinary course of business.

20. AFFIRMATIVE COVENANTS OF SELLER PENDING CLOSING

Consider using the following paragraphs such that from the date of the Business Sale Agreement and until the closing, Seller will:

[  ] Conduct its business only in the usual course of business.

[  ] Maintain the assets and the business.

  • [  ] including employee and customer relationships.
  • [  ] including business records and accounts.

[  ] Pay all costs of operating the business as they become due and all liabilities existing on the closing date unless assumed by Buyer.

[  ] Comply with all laws.

[  ] Not breach any of the contracts or cause any representation or warranty of Seller to be untrue.

[  ] Keep all insurance in effect.

[  ] Allow Buyer or Buyer's representatives reasonable access to the facilities, assets and records.

21. SURVIVAL OF REPRESENTATIONS, WARRANTIES AND COVENANTS

Consider using the following paragraph such that all of Seller's representations, warranties, covenants and agreements will survive the closing.

[  ] for a period of _____ years.

22. OTHER OPTIONAL PARAGRAPHS:

EXPENSES. The standard Business Sale Agreement states that Buyer and Seller will each pay their respective expenses in connection with this transaction. Consider using the following paragraph if a business broker is involved in the transaction.

   [  ] Seller is responsible for any broker fees.

SUCCESSORS AND ASSIGNS. The Business Sale Agreement will be binding on the successors and assigns of the parties.

CONSTRUCTION. The Business Sale Agreement will be governed by the laws of the State of ________________. If any provision of the Business Sale Agreement is ineffective, the other provisions are not affected.

COUNTERPART/ELECTRONIC SIGNATURES. The Business Sale Agreement may be executed in counterparts, and may be accepted by sending an executed copy of the signature page electronically if the original is also mailed on the same date.

ENTIRE AGREEMENT. The Business Sale Agreement contains the entire agreement of the parties with respect to the subject matter and cannot be modified unless in writing and signed by all the parties.


Comments to Help You Complete the Sole Proprietor Due Diligence Checklist

  • Assets (paragraph 4): For a sole proprietor (or partnership), the proper agreement is an agreement for the sale of assets. For sole proprietors and partnerships there is typically no stock or other forms of ownership. Therefore, the Buyer will be purchasing all the assets the company owns. "Asset" is a broadly defined term, it includes everything "owned" by the business, from real property, to intellectual property (software code, patents, trademarks), to something as intangible as "goodwill". If particular assets are not to be sold, it is important to list them specifically in the sale agreement.
  • Closing Inventories (paragraph 5): Think carefully about how inventory is kept in your business, and how that inventory is tracked. If the buyer is purchasing all the inventory you may need to itemize the inventory (depending on the terms of the sale agreement). Consider using the optional phrases listed above to accommodate how you would like to account for and sell your inventory.
  • Accounts Receivable (paragraph 6): If any of your accounts receivable are very aged, or may be uncollectible, make sure to disclose those facts to the Buyer and then specifically account for them in the agreement, either through a positive statement that Buyer purchases all accounts receivable at face value, regardless of potential set-off, or whatever accommodation you choose.
  • Environmental (paragraph 7): If there are any potential environmental issues on any property controlled or owned by the Seller, it is important to identify them and disclose them to the Buyer. Additionally, it is important to clearly state in the sale agreement which party will be responsible for resolving any environmental problem.
  • Employees (paragraph 8): It’s important to understand and identify any potential employee issues before signing the final agreement, and to adequately describe each party’s responsibility for employee issues in the agreement. These issues could be anything from accidents on the job, sexual harassment claims, wage issues, Department of Labor audits, etc. The most crucial thing is the be thorough in identifying any potential problems and then explicitly agree how issues will be resolved and which party will be responsible for the resolution.
  • Covenant Not To Compete (paragraph 9): Non-compete agreements are extremely important to Buyers and may seem less important to Sellers. However, remember that signing a non-compete will severely limit your ability to work in the same field or industry for a long period. Some states (California particularly) are becoming less friendly to these types of agreements, but in the majority of the United States they are still strongly enforced. Consider limiting the scope of your non-compete and reducing the number of years it is effective.
  • Consulting Agreement (paragraph 10): It is important to Buyers to know that key employees will remain with the company, and that previous owners will be available for questions, consultation, and work in the beginning years the new owners familiarize themselves with company operations. Therefore, consulting agreements are common to "lock in" former owners and key employees. The successful signing of these agreements is often a prerequisite to competing any deal. You should carefully consider the terms and conditions proposed by the Buyers as these documents will legally bind you to work for the new owners for a certain period of time.
  • Items to Be Delivered by Seller at Closing (paragraph 14): Carefully consider each document required in this section (or whichever documents are included in the final sale agreement) and be sure you will have no problem producing them. Sometimes these documents may not be in your control, or may be difficult to find, so begin early in finding them and making sure they are the most accurate and up to date version of the documents possible.
  • Conditions Precedent to Buyer’s Obligations (paragraph 17): These are conditions which must exist before a Buyer will be obligated to sign the final sale agreement. Sellers should understand that the more provisions included in this section, the more favorable to the buyers the agreement becomes. Remember, all the conditions set forth in this paragraph do not necessarily need to be included in an agreement. Consider which of them you feel is fair to include and consider removing or adding any other "conditions".
  • Representations of Seller (paragraph 19): These are the representations the Sellers make to the Buyer concerning the status of the business as of the closing date of the agreement. Remember, these are conditions which the Seller represents to be true, therefore the Seller should: a) limit these representations as narrowly as possible, and b) Assure the representations are true and accurate before signing the final agreement.
  • Negative Covenants of Seller Pending Closing (paragraph 21): This paragraph describes certain promises the sellers agrees to between the date the agreement is signed and the closing date of the transaction. These are "negative” covenants which means they are promises to refrain from certain behavior. These covenants are very important and the Seller should carefully examine them to make sure they are prepared to abide by these terms. Remember, the more terms in this paragraph the more potential liability there is for the Seller. If you feel uncomfortable about any of them don’t hesitate to negotiate their removal or at least limit their scope.
  • Affirmative Covenants of Seller Pending Closing (paragraph 22): These promises are similar to those in paragraph 21 except these are "affirmative" covenants, which means they are activities or behaviors the Seller must do before closing. Again, these covenants are very important and the Seller should carefully examine them to make sure they are prepared to abide by these terms. Remember, the more terms in this paragraph the more potential liability there is for the Seller. If you feel uncomfortable about any of them don’t hesitate to negotiate their removal or at least limit their scope.
  • Risk of Loss (paragraph 25): This paragraph places the risk of loss of assets on the Seller. For example, if a fire were to burn down your warehouse and all your inventory was lost, the Seller would be solely responsible to bear the financial burden of that loss. Typically, this is not an issue because the Seller will retain its insurance against such losses until the closing date when such responsibilities pass to the buyer. It is, however, important to examine your business and make sure you are properly protected during the period before closing, canceling insurance policies, or other changes to protective measures is not advised.


The checklist was created and commented by Douglas Bean, JD



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