Confidentiality Agreements

Maintaining confidentiality is essential when it comes to selling your business and one of the primary tools for doing so is a properly drafted non-disclosure agreement. Many critical issues that will help preserve confidentiality are addressed in a properly drafted NDA, including non-solicitation and other “sales process” issues. While it’s tempting to assume that all NDAs are boilerplate, a mistake at the stages of negotiating and signing a non-disclosure agreement can close off critical options later in the process. In extreme cases, leaks can destroy your business. 

In nearly every M&A transaction, a confidentiality agreement (CA) is executed, but a CA is only one of many tools in your toolkit you can use to maintain confidentiality during the sale process. The information in this section is essential if the terms of a confidentiality agreement are crucial to the sale of your business, especially if you’re approaching direct competitors, which always carries a high risk.

Topics Covered

At a minimum, an NDA will usually cover the following:

• The definition of confidential information
• Restrictions on using the confidential information
• Obligations of the recipient
• Standards of care
• Term
• Remedies
• Permitted disclosures
• Return of confidential information
• Disclosure period
• No obligation to proceed
• No grant of IP rights
• Enforcement
• Law and jurisdiction
• Dispute resolution

With regard to the confidential information, the buyer is obligated to the following, assuming the NDA is properly drafted:

• Use the information only for purposes described in the agreement.
• Disclose the particulars only to persons with a need to know the facts for purposes of evaluating the transaction.
• Make appropriate or reasonable efforts to keep the data secure.
• Ensure that anyone to whom the information is disclosed further abides by obligations restricting its use and ensuring security at least as protective as the agreement.
• Not share the specifics with third parties, unless required to by law, for a minimum period of time, typically one to five years.
• Safeguard the information they receive with reasonable precautions that are at least as stringent as the safeguards they use to protect their own information.
• Not reverse engineer or decompile the data.
• Notify you of any leaks of the disclosed information.
• Comply with all government rules and regulations, including export and import laws.
• Cease use of the details and return it to you upon termination of the NDA.

The Importance of a Properly Drafted NDA

A properly drafted confidentiality agreement sets expectations with buyers, which is critical to the M&A process. A well-prepared agreement signals to buyers that you’re well represented.

The language in M&A confidentiality agreements has evolved over the years and is no longer restricted to language that addresses only confidentiality. Despite the implication of the name “confidentiality agreement,” many additional critical issues are often addressed in the agreement, such as non-solicitation and other sales process issues. 

If an investment banker represents you, expect your advisor to have a template. Because most M&A advisors represent sellers, their template will be seller-friendly. If your situation is unique, consult with your attorney to draft a custom NDA. In most cases, buyers request few changes to the language contained in your NDA, but you should be prepared to negotiate the terms of the agreement as requests can vary depending on who the buyer is.

In practice, most NDAs are drafted by the disclosing party, which is usually the seller in M&A transactions. Sellers negotiate with multiple buyers, and maintaining consistent language across the agreements simplifies the process for them. Most NDAs never make it past the first stage of selling a business when the information memorandum is released to the buyer, and you may execute NDAs with dozens of potential buyers during the sale process.

A properly drafted confidentiality agreement sets expectations with buyers, which is critical to the M&A process.

Goals of a Non-Disclosure Agreement

There are two main goals of drafting an NDA – controlling the behavior of your buyer and offering mechanisms for litigation. The specifics of these two goals are as follows: 

Goal 1: Control Behavior

The primary goal of the NDA is to prevent confidentiality breaches from happening in the first place. If the terms of the NDA are clear, this objective is likely to be achieved. Therefore, drafting an NDA that’s clear, concise, and devoid of legalese is important.

That being said, it’s often wise in smaller transactions to reiterate the confidential nature of the information to the buyer during the initial phone conversation or meeting. This is doubly important if you believe the competitor hasn’t completed any acquisitions before and isn’t aware of the importance of confidentiality. 

If the buyer attempts to negotiate the language of the NDA, this can be a good sign. Unfortunately, some buyers don’t thoroughly read the terms of the NDA and inappropriately assume that the language in the NDA is boilerplate. Therefore, when a buyer attempts to negotiate the language of the NDA, you know they’ve read it through, which is good. This can be an indication that the buyer closely monitors their commitments and intends to abide by them.

Goal 2: Offer a Mechanism for Litigation

If an NDA is violated, your primary option is to litigate. While you can deliberate for hours regarding the definition of confidential information, it won’t matter if the buyer doesn’t understand the language contained within the NDA. With that being said, I believe the primary goal of an NDA is to control and prevent the behavior, which is Goal 1. If the first objective to “control behavior” is achieved, litigation, which is the second objective, isn’t necessary. If the NDA doesn’t achieve the first goal of controlling behavior, your only remaining option is to sue the buyer to enforce its terms. Luckily, this is rarely necessary, despite the fact that this is one of the main objectives of a non-disclosure agreement. If you do need to litigate, a well-drafted non-disclosure agreement will contain mechanisms that facilitate its enforcement, whether that includes an injunction, liquidated damages, or arbitration.

Now that the purpose of the NDA has been explained, here are several tips on how to strengthen the NDA when dealing with direct competitors.

There are two main goals of drafting an NDA – controlling the behavior of your buyer, and offering mechanisms for litigation. 

Prepare a Buyer-Specific NDA

Ask your attorney to prepare an NDA specific to the buyer with whom you’re negotiating. A standard NDA is normally sufficient during the preliminary stages with most buyers. But, if you’re dealing with a direct competitor and are releasing highly sensitive information to them, your attorney should prepare an NDA specific to that buyer. 

An NDA often has to be customized for certain types of buyers. Using a boilerplate NDA can leave you open to loopholes depending on the type of buyer. For example, we manage private equity firms differently than competitors. Our process is more stringent with competitors. In middle-market transactions, the terms of an NDA are negotiated with most buyers, especially if the buyer is a potential competitor. Therefore, because the language can vary in an NDA, it makes sense to afford yourself more protection when dealing with direct competitors. 

Topics to consider modifying if you’re dealing with a competitor include:

• Is information that’s communicated orally included? 
• Is “derived information” included?
• Is the fact that your business is for sale considered confidential information?
• What is the definition of “representatives”?
• What is the definition of “confidential information”?

You can also consider including the following language in the NDA when dealing with a competitor:

• Non-Solicitation: Include language in which the buyer agrees to not actively solicit your employees. See tips below for when to introduce this language.
• No-Hire: With a no-hire, the buyer agrees not to hire your employees, as opposed to not soliciting them.

Prepare a Separate NDA for Different Categories of Information

Separate NDAs can also be prepared for different categories of confidential information, with different language necessary for different scenarios. 

For example, each of these scenarios may require a different set of legal strategies and language to protect you – the buyer meets with key employees vs. if the buyer meets with key customers vs. if you share proprietary pricing with the buyer.

Ask the Buyer’s Representatives to Sign an NDA

Always ask the buyer to obtain a signed NDA from their representatives before releasing your information to them. If the representatives don’t sign the NDA, the buyer should be held liable for any breaches made by their representatives. The buyer should also disclose their representatives’ names and contact information if they receive information on your business. 

Have the Buyer Sign Multiple NDAs

Ask the buyer to sign a different NDA at different points in the transaction as the negotiations progress and as you provide additional confidential information to the buyer in stages. Each NDA can contain progressively more restrictive language and terms as you release more sensitive information. 

For example, a buyer may not be interested in signing an NDA that contains a non-solicitation or a no-hire clause early in the process. But, the buyer may agree to this NDA language later in the process if you agree to let the buyer meet with your employees during due diligence. 

It may be necessary for your attorney to draft an NDA before you allow the buyer to meet with key customers. This is rare in most transactions, but there may be cases where customer concentration is an issue, and the buyer may want to talk with key customers before they agree to close. If this is the case, it may be necessary to negotiate an NDA with the buyer before allowing such conversations to take place.

How an NDA Fits in the Sale Process

For transactions in the middle market, most intermediaries first provide a teaser profile to the prospective buyer before requesting that the buyer sign an NDA. Middle-market buyers prefer to see if the business is a good fit before committing to the terms of an NDA. The teaser profile and NDA are often contained in the same document, and the buyer is asked to sign the NDA if they’d like to access the confidential information memorandum (CIM) on your business. Since moving forward is contingent on this document, the NDA is usually signed early in the process.

When to Execute a Confidentiality Agreement or NDA

The NDA is usually the first document signed in a transaction and sets the tone for the negotiations, making it a critical component in the sale process. Depending on the type of business you’re selling, the name and location of the business can be highly sensitive. You may want to protect that information until you know the buyer is genuine and sincere.

The goal of your intermediary is to protect your sensitive and confidential information while providing enough information to a potential buyer so the buyer can decide whether to pursue your business. Needless to say, this is a delicate balancing act. 

If your business is being sold through an M&A intermediary, the NDA will usually be executed before your business’s name is disclosed. If an owner has been approached by a competitor directly, an NDA is often signed before substantive discussions take place or before you share confidential information with the buyer.

The NDA is the first document to be signed in a transaction and sets the tone for the negotiations, making it a critical component in the sale process. 

Types of NDAs

There are two basic types of NDAs – a unilateral NDA and a mutual NDA. Most NDAs don’t clearly state whether the document is unilateral or reciprocal, but this can be discerned after briefly reading the contract. Here are the basic differences: 

1. Unilateral: Only one party is obligated not to disclose confidential information in a unilateral or one-way agreement. Most NDAs when selling a business are unilateral, whereby the buyer is the recipient and you’re the disclosing party, and you have no reciprocal obligations.
2. Mutual: In a bilateral or mutual agreement, both parties provide information that’s intended to remain secret. This type of agreement is common when businesses are considering some form of a joint venture or merger.

Nuances in Buyer Groups

As a matter of custom, nearly all private equity firms will agree to sign an NDA. On the other hand, venture capitalists, who are financial buyers investing in speculative opportunities, rarely agree to sign NDAs. Entering into an NDA increases the risk that the venture capitalist (VC) may face charges of trade secret misappropriation if the VC develops similar information in the future or inadvertently discloses or uses the information. This is the primary reason that VCs don’t sign NDAs.

Problems, Tips, and Strategies

Even savvy sellers run into problems regarding the nuances of the language in NDAs, the timelines of negotiations, and specific definitions. Here are some common issues I’ve seen, along with tips for avoiding or navigating through them: 

• Definition of Confidential Information: Problems with confidentiality agreements arise when the “confidential information” that the agreement intended to protect is defined so broadly that it’s impossible, as a practical matter, to determine what it covers and whether that information is truly deemed confidential. 
• Protecting Trade Secrets: Despite the importance of the NDA in maintaining trade-secret protection, confidential information may still be vulnerable to disclosure in various ways. There’s also a risk of litigating trade secrets in open court, where disclosure is a necessity and enforcement can be uncertain. Perhaps even more important, signing an NDA with your counterparty helps to generally maintain the status of your confidential information as trade secrets. Courts will typically protect the secrecy of information deemed to be “trade secrets.” In order for your information to qualify as trade secrets, though, the information must be kept secret or, if the information is communicated to a third party, the third party must be pledged to secrecy. The NDA serves as this pledge, and your trade secrets ideally will still be afforded the general protection of the courts.
• Use a Phased Release of Information: To minimize the risks, I recommend a phased release of information in which confidential and sensitive information is released in stages, as opposed to all at once. For example, you can release more sensitive information, such as pricing and customer names, at the later stages of the transaction, if at all.
• Use the Correct Legal Names of the Parties: Finally, ensure that you include the correct legal names of individuals or companies in any agreement. Getting any details wrong could leave you on dodgy ground if you have to enforce the agreement.

FAQs About Non-Disclosure Agreements

Here are some of the most common questions about NDAs:

How common is it to negotiate confidentiality agreements?

It’s rare for parties to refuse to negotiate the terms of an NDA. The first draft is always negotiable, but the degree to which the parties negotiate depends on their individual bargaining strength. Every buyer, whether a corporate or financial buyer, has their own idiosyncrasies in terms of the language they look for in an NDA, based on the history of their transactions and what may have gone wrong in the past. In practice, a minority of buyers request changes to a confidentiality agreement. But, the later you request an NDA from a buyer, the more prone a buyer is to attempt to negotiate the terms of a non-disclosure agreement. To prevent a buyer from attempting to negotiate a non-disclosure agreement, it’s best to request that they sign one as early as possible in the process.

The first draft is always negotiable, but the degree to which the parties negotiate depends on their individual bargaining strength. 

What’s the role of my attorney and M&A advisor?

Every M&A advisor will have a template they use when drafting a non-disclosure agreement. Your attorney will become involved if you have unique needs, such as trade secrets that need to be protected, if your marketing strategy includes approaching competitors, or if a buyer requests significant changes to your investment bankers template.

Do advisors sign NDAs?

Private equity firms nearly always sign non-disclosure agreements when scouting for acquisitions, but few venture capitalists will sign them. Most M&A advisors and investment bankers will sign an NDA, though some will view the request as naive due to their implied duty of confidentiality. Professionals, such as PE firms, venture capitalists, M&A advisors, and investment bankers, wouldn’t be working for long if they were in the business of stealing ideas. Attorneys and accountants will sometimes sign an NDA if the situation is unique, such as if they’re a part-owner in a competitive firm, but they’re bound by an implied duty of confidentiality, so requesting them to sign an NDA is considered unnecessary in most situations.

Should you sign a buyer’s “standard NDA”?

There’s no such thing as a “standard NDA.” Attorneys and M&A advisors have templates, but those vary drastically from company to company. So always ask your attorney to review the NDA before signing. Any company with a legitimate interest will be willing to negotiate the terms of its NDA.

Are NDAs one-way or two-way agreements?

Many NDAs are drafted as one-way agreements in which you only attempt to restrict the buyer’s actions. Buyers often modify the NDA if they’re disclosing confidential information to you, or at least to protect the terms of the transaction, so you can’t shop the buyer’s offer.

What’s signed after the confidentiality agreement?

A letter of intent is customarily signed after the parties have exchanged information and the buyer has expressed an interest in moving forward into due diligence. After due diligence is completed, the parties replace the LOI with a definitive agreement, such as a purchase agreement, asset purchase agreement, or definitive purchase agreement. This definitive agreement is normally signed at the closing to consummate the transaction, although in some cases, it may be signed in advance of the closing.

Can the buyer disclose the specific terms of the negotiation after the CA expires?

Yes, unless the CA specifically prohibits this. An alternative is to remove the expiration date altogether, though a majority of buyers will argue that it may be difficult to monitor compliance with the agreement long-term if there’s no expiration date. It’s also important to note that some jurisdictions may not allow a perpetual term.