Most businesses are held and operated by an entity that is created under state law by filing a document with the secretary of state, and which is treated under state law as a legal person separate from its owner(s). Thus, when the business is sold, whether in an equity sale or an asset sale, the purchaser’s focus is mostly on the entity. Because the business assets and liabilities are contained within the entity, the purchaser’s due diligence is focused on the entity’s assets, liabilities, and contractual relationships.
At least two complications arise when a business is held as a sole proprietorship, one having to do with transferring the business and the other involving due diligence. First, because the sole proprietorship isn’t an entity separate from its owner, an equity sale isn’t possible. Also, special care must be taken to clearly define which assets are being acquired by the purchaser. For example, if a purchaser desires to purchase substantially all of the assets used in a corporation’s business, it is a fairly simple matter of defining the purchased assets as all of the target’s assets, except for a few usual exceptions such as the company’s cash. When a business is held as a sole proprietorship, however, the owner of the business assets is the sole proprietor, not an entity, and the owner’s assets are intermingled with the business assets. Thus, it is important to clearly define which assets belong to the “company” and which do not when drafting the asset purchase agreement.
The other complication involves due diligence issues. The sole proprietor will not have separate tax returns for the business because he or she probably reports income from the business on Schedule C of his or her individual tax return. So the purchaser must review the personal tax returns of the seller. Also, when doing lien and judgment searches, the purchaser must investigate potential liens filed in the individual name of the owner as well as those filed in the name of the company. This complicates the searches and runs up the bill if a third-party search company is engaged. Finally, if any of the assets are owned by the sole proprietor’s spouse, or owned jointly with the sole proprietor’s spouse, the purchaser must ensure to include the spouse as a party to the purchase agreement.
I’ve personally only seen transactions involving sole proprietorships in very small deals, but I’ve heard of large, successful sole proprietorships. Since they exist, buyers and their advisors might have to navigate issues that are unique to sole proprietorships.