How to Ensure Confidentiality

When it comes to selling your business, time is fickle. It’s your friend before your business is on the market, and your enemy the moment your business is on the market. The longer it takes to sell your business, the higher the probability of a leak. And that’s not good for business. 

There are three primary reasons for maintaining confidentiality:

1. Employees: If your employees learn about the sale, they may become nervous regarding their job security. As a result, they could begin to look for employment elsewhere. In other cases, employees can feel betrayed and could form a small coalition to compete directly with you. 
2. Customers: Both existing and potential new customers may learn of the possible sale and become nervous that a new owner may substantially change your business model or increase pricing, so they could begin looking for alternate solutions through your competitors.
3. Competitors: Competitors may use knowledge of the sale to poach your employees and customers, or cause other harm to your business. 

Doesn’t a non-disclosure agreement (NDA) ensure confidentiality, you may ask? A signed NDA alone doesn’t assure confidentiality, but it’s a critical component of doing so and prevents a leak in most cases. But as a rule of thumb, the longer it takes to consummate a transaction, the higher the probability word will get out prematurely.

The real purpose of a confidentiality agreement is prevention, but it’s not the only tool you should use. A well-drafted NDA should be combined with additional actions for maintaining confidentiality. 

Prepare for the Sale in Advance 

An ounce of prevention is worth a pound of cure, and selling your business is no different. To preserve confidentiality, ideally, you should prepare for the sale years in advance. The right preparation goes a long way in ensuring a quick, smooth transaction, thereby minimizing the possibility of a leak and its consequential damage. 

Inform Employees 

In most cases, the only way an employee’s career can grow is if your business grows. At the same time, most entrepreneurs reach a stage where they’re “milking the cow” and no longer have the desire to grow their business. This limits employees’ growth, which can be demotivating for your staff. Luckily, most employees understand there’s a time for every entrepreneur to sell. New ownership makes sense at key stages in the life cycle of any business, which can spell opportunity for a driven employee. 

For example, if the buyer is significantly larger than your company and has access to more resources, a new owner may provide a pathway of growth for employees through opportunities outside the organization. Imagine if 3M bought a $20 million company. Which situation would offer an ambitious employee more opportunity – a career at the $20 million company or in any one of countless divisions at 3M? In addition, new ownership may also bring capital to the table to expand the business, which could represent another opportunity for superstar employees. In nearly all acquisitions, the buyer desires to significantly grow the business post-closing and is willing to take significant risks in doing so. That means that the sale of your business could offer your employees opportunities for growth and upward mobility. 

On the flip side, employees resting on their laurels may be understandably nervous about the prospects of new ownership. To be sure, the majority of employees are honest and hard-working, but there are bad apples in any bunch. In several cases, buyers have told me they found some employees who were barely working in a business, yet they were receiving full salary and benefits. A transition can be an excellent means of purging the business of this “dead weight.” 

Draft a Non-Disclosure Agreement

While an NDA isn’t bulletproof, it does prevent a leak of confidentiality in most cases. Often, a leak is negligent, and the offending party isn’t intentionally trying to harm your business. The real purpose of a confidentiality agreement is leak prevention, but it’s not the only tool you should use. A well-drafted confidentiality agreement should be combined with additional actions for maintaining secrecy. As an example, for highly sensitive information released to competitors, it may be wise to enter into a separate agreement or a multi-part NDA that addresses the disclosure of that information. I’ll dive deeper into NDAs further in this chapter, but for now, just know that they’re an important tool in maintaining confidentiality.

Contact Buyers Based on Increasing Stages of Risk

When selling your business, contact buyers that represent the lowest risk to you and your company first in the process. Typically, this involves initially contacting private equity (PE) firms and indirect competitors. This is the de facto standard in most private auctions if you hire an M&A advisor to represent you.

By first contacting the low-risk, low-priority group of buyers, you reduce the risk of potentially ruining a first impression you make with high-priority buyers. The first buyers you contact will inevitably point out potential drawbacks, deal-breakers, or other weaknesses they see in your business as they consider acquiring your company. No matter how much prep work you do, there will always be small details you miss in preparing your company for sale. Contacting low-risk buyers first allows you to tighten up future buyer presentations and increases the chance of a smoother transaction.

We recently sold a large commercial cleaning company using this strategy. We initially contacted a few dozen out-of-state competitors who could benefit from expanding their geographic reach. We considered these competitors low-risk since they weren’t directly engaged in the business’s geographic market. Our strategy was to contact direct competitors only as a last resort. We started with low-risk potential buyers and were able to sharpen our approach until we found the right buyers.

Thoroughly Screen Buyers

Not only should you ask all interested parties to sign a non-disclosure agreement, but you should thoroughly screen these buyers before you provide them with sensitive information on your company. Following are several tips for doing just that:

• Thoroughly Qualify the Buyer: It’s important to ensure the buyer is qualified before you share confidential information. As due diligence progresses, you can make more detailed requests.
  • At Morgan & Westfield, we ask interested parties, including competitors, to complete a buyer profile that asks dozens of questions relating to their financial position and any past acquisitions they have made. We do this before we release any information to them regarding a business. If the buyer refuses to respond to our questions, we don’t provide any additional information about the business to them.
  • If the buyer demands to talk to customers in the latter stages of due diligence, you can respond that you’d like to talk to some of the owners of past companies they’ve acquired, or other contacts.
• Hire a Private Investigator: An experienced private investigator can also be a useful resource, with access to databases and other information, and may be able to identify someone with a less-than-pristine reputation quickly. A private investigator can also rapidly dig up information on the buyer if you’re concerned about the buyer’s credibility.
• Ask Your Attorney to Search Public Records: Looking into public records will show how many times a buyer has been involved in litigation, if at all, and may discover other potential issues.
• Obtain Detailed Financial Information: Verifying the buyer’s ability to complete the transaction is a good idea if you have any doubts regarding the buyer’s ability to buy. Go with your gut. If you have doubts regarding specific areas, dig into these areas further. 
• Talk to Past Targets: If the buyer makes questionable claims regarding several of their past acquisitions, ask to speak with the owner of a company they have acquired. This request is certainly within your rights, especially if the buyer asks you for highly sensitive information.

Release Information in Phases

You shouldn’t give sensitive information to the buyer all at once. Rather, you should release it to them in stages.

As the buyer demonstrates continued interest in your business, you can disclose more and more information. In this manner, you release more sensitive information as you come to know and trust the buyer over time. You should divulge highly confidential information such as customer contracts only at later stages of due diligence. 

Release general information in the early stages of any conversation with a potential buyer. Withhold sensitive data – or any other form of information that a competitor could use against you – until later in the transaction. Only provide sensitive information much later in the process, or not at all.

You can also impose deadlines on the buyer. In some cases, you can break due diligence into stages and ask that the buyer sign off on the completion of each stage. 

For example, you can allow the buyer to perform financial due diligence first. Once they have done so, you can request they sign off on the satisfactory completion of that stage before moving to the next phase of due diligence. 

While this strategy might be possible for some businesses, it’s impractical in most acquisitions due to the iterative nature of due diligence. A more straightforward solution is to simply withhold sensitive information until the later stages of due diligence.

Know What to Release and When

Next, I’ll clarify what information is regularly, sometimes, and not shared with buyers.

Information that’s regularly shared with buyers:

• Financials and Taxes
  • Profit & loss statements 
  • Balance sheets
  • Cash-flow statements
  • Bank statements
  • Federal income tax returns
  • Payroll and sales tax reports
  • Merchant account statements
  • Accounts receivable and payable schedule
• Legal
  • Copy of the lease for the premises
  • Copies of supplier and vendor contracts
  • Advertising contracts
  • Copies of insurance policies
  • Copies of equipment leases
  • Copies of material contracts
• Operations
  • Asset list
  • Inventory list
  • Marketing material and collateral
  • Copies of licenses, permits, certificates, and registrations

Information that is sometimes shared with buyers:

• Pricing with specific customers or clients
• Customer contracts, but names are often redacted
• Employee names, agreements, and other information
• List of suppliers

Information that is not regularly shared with buyers:

• Software code – although they may conduct a code audit through a third party
• Customer names – current and prospective
• Trade secrets

Control How Information Is Released

Controlling how information is released is foundational to maintaining confidentiality. If you’re releasing highly sensitive information, you can often limit who this information is released to by using the following strategies:

• Screen Buyers: As I’ve already said, thoroughly screen all buyers before releasing any information. All buyers should be screened financially, and direct competitors should be screened with extra diligence. Due diligence is a two-way street – you should also verify the buyer’s financial position during due diligence before releasing sensitive information. Verify how many acquisitions they have previously made and request to talk to several CEOs of their past acquisitions. If you encounter warning signs, slow down and dig deeper. 

In one case, we sold a company to a private, wealthy individual who stole the funds he used to purchase the business from a trust, of which he was the trustee. While such cases are rare, if doubts are raised, trust your gut and dig deeper.

• Set up an Electronic Deal Room: If you’re negotiating and conducting due diligence with multiple parties simultaneously, it may be wise to release all information through an electronic data room, which tracks who accesses information and provides you with controls, such as limiting the ability of buyers to download or print information.
• Email Information to Create a Document Trail: Email as much information as possible to create a document trail in the event litigation needs to be pursued. This documentation can provide you with leverage if you need to threaten litigation, such as when the opposing parties weigh the potential merits of a case before initiating a lawsuit. Since the evidentiary burden is on you in most confidentiality agreements, the more documentation you possess, the more leverage you’ll have to reach a quick resolution in the event of a breach.
• Redact or Aggregate Information: Consider sharing summaries of sensitive information in which key data such as customer or employee names is redacted.
• Release Information in Phases: Release information to buyers in phases as the sale progresses and as transaction milestones are achieved, such as completion of financial due diligence. At each milestone, request that the buyer sign off on its completion. For example, names of key customers or employees should only be released at the tail end of due diligence, or after the purchase agreement is negotiated and executed.
• Develop Strategies for Different Types of Information: Highly sensitive information subject to misappropriation by the buyer could be summarized, shared with neutral third parties, or shared only in summary form with the buyer. You should exhibit extreme caution in areas of unprotected trade secrets and other non-registered IP.
• Release Sensitive Information to a Neutral Third Party: In the case of extremely sensitive information, it’s possible to appoint third parties to review the information and prepare a summary report to present to the buyer. 

In one large transaction we handled, representing the seller, two customers accounted for 40% of the annual revenue. The buyer was concerned due to the risk associated with the high concentration of revenue, but the seller was unwilling to let the buyer talk directly with the customers. We hired a third-party firm to perform customer surveys and prepared a summary report to present to the buyer.

• Limit Information to a Select Party: Alternatively, you can limit information to specific people or departments within the buyer’s organization, such as the buyer’s CPA, attorney, or CFO. When doing so, the third party should also sign an NDA. If you take this route, the terms of the agreement may need to be modified, for example:

“Buyer agrees that select evaluation material will be provided only to Buyer’s outside advisors and that Buyer will not disclose such information to Buyer’s employees in its marketing, research and development, technology or finance departments.”

• Use the Attorney-Client Privilege: Omit documents from the data room that are subject to the attorney-client privilege, such as those that might be relevant to recent litigation. In other words, if you’re in the process of litigation, be sure to disclose any documents pertinent to the litigation exclusively through your attorney. Note that in the event of a successful transaction, the buyer may share a common interest with you if the buyer becomes a “successor defendant.” But, this privilege isn’t guaranteed, especially if the transaction is unsuccessful. It’s therefore wise to limit disclosure of any litigation-sensitive information exclusively through your attorney to retain the attorney-client privilege.

Mark or Stamp Documents “Confidential”

Stamp or watermark all documents “Confidential” before releasing them to the buyer. While this isn’t a requirement of most NDAs, it’s a good practice and clearly communicates to the buyer the confidential nature of any information you share with them.

Appoint a Neutral Third Party to Facilitate Due Diligence

There’s always risk involved with sharing your sensitive business information during the sales process. An important step in mitigating those risks can be appointing a neutral third party to perform due diligence on behalf of the buyer. For example, the buyer can retain an independent third-party CPA firm to perform financial due diligence if you must share sensitive financial information. In these cases, the third party would only serve to perform due diligence – they wouldn’t pass on any of the confidential information to the buyer.

For example, if you own a software company, you and the buyer could jointly hire a third party to perform a code audit. The third party would be the only contact to have access to your software code. After they complete their code audit, they would prepare a report and present it to the buyer for analysis, limiting the number of contacts with access to your confidential software code.

A second scenario may be one in which your business has high customer concentration, and the buyer is concerned about retaining your top three customers, who account for 70% of your revenue. In this case, a third party could be hired to perform customer surveys to ensure your top clients are satisfied and are likely to be retained. A transaction could also be structured to obscure the fact that the company was acquired. We recently employed this strategy to sell a large service firm in Chicago.

Handle Breaches Immediately 

Leaks in confidentiality rarely cause permanent damage. In most cases, unintentionally loose lips cause a leak, and a quick phone call to the offending party quickly reverses the damage, if any.

In the event of a breach, immediately call the offending party. Assess their reaction to the news and their tone – listen to their story before taking any dramatic action. In most cases, the other side will apologize and immediately take steps to correct the action, such as firing the employee who initiated the breach or calling the customer to reconstruct the narrative of the story. 

When a breach isn’t clear, a phone call may serve to raise the other party’s awareness of the issue, and in most cases, the story will quickly disappear. Send an email to confirm your conversation and any actions they’ve agreed to take. This creates a paper trail in the event you need to pursue litigation in the future.

Handling Buyers Who Want to Talk to Employees

Unfortunately, buyers sometimes want to talk to some of your employees during the due diligence period. If they do, I recommend saying no and standing your ground. But, doing so requires having a poker face and a solid resolution to stand firm. Most buyers will give in, move on to other issues, and forget about it. Some buyers, however, absolutely insist. If the buyer insists on talking to a few select employees about the sale, do so only after all other due diligence matters and other contingencies have been resolved, such as financing or the transfer of the lease. In other words, the sale should be ready to close, and this should be the only remaining step.

Key Points

Maintaining confidentiality is a critical component of selling your business. A confidentiality agreement is one of many strategies to preserve privacy. A well-drafted confidentiality agreement should be paired with the strategies recommended above to ensure discretion is maintained throughout the sales process.