M&A Guide | Selling Your Business to a Competitor

Executive Summary

A competitor recently approached me and inquired about buying my business. I’m interested in talking with them, but I’m nervous. I don’t know if they are fishing for information or if they have a legitimate interest. I am reluctant to accept the offer since I know I must share sensitive, confidential information with them. What precautions can I take to ensure the non-disclosure agreement protects me as much as possible? Is there anything I can do to protect my trade secrets and other confidential information when dealing with a competitor?

Keeping the details of your business secure and confidential is critical at any time, especially when a competitor approaches you.

This article explores the following strategies you can employ to protect yourself when selling your business:

• Contact buyers based on increasing stages of risk
• Thoroughly screen buyers
• Release information in phases
• Know what to release and when
• Mark or stamp documents “confidential”
• Appoint a neutral third party to facilitate due diligence
• Prepare a custom or buyer-specific non-disclosure agreement (NDA)

Let’s get started!

Contact Buyers Based on Increasing Stages of Risk

First, contact buyers that represent the lowest risk to you and your company. Typically, this involves initially contacting private equity firms and indirect competitors.

Dealing with these buyers represents the lowest level of risk to your business. This is the de facto standard in most private auctions if you hire an M&A advisor to represent you.

This strategy of first contacting low-risk buyers lets you polish your presentation and positioning before contacting higher priority or higher-risk buyers. The first buyers you contact will inevitably point out potential drawbacks, deal-breakers, or other weaknesses they may see as they consider possibly 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.

By first contacting the low-risk, low-priority group of buyers, you don’t risk ruining the first impression with high-priority buyers. Such a strategy always yields useful feedback that can be used to tighten up future buyer presentations and increases the chance of a smoother transaction.

We recently sold a large commercial cleaning company, and this is the strategy we used. 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 were not directly engaged in the business’s geographic market. In another instance, we employed a similar strategy to sell a large landscaping company; however, in this scenario, we contacted indirect competitors in the geographic market. We considered this lower risk as the companies were ideal acquisition candidates, but they were not direct competitors. Our strategy was to contact direct competitors only as a last resort. In both of these cases, we started with low-risk potential buyers and were able to sharpen our approach until we found the right buyers for each business.

Thoroughly Screen Buyers

Thoroughly qualify the buyer before releasing information. It’s important to ensure the buyer is qualified before you share confidential information, and you can get more detailed in your requests as due diligence progresses.

We ask interested parties, including competitors, to complete a “Buyer Package” 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 complete this information, we do not 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 would like to talk to some of their key employees, owners of past companies they have acquired, or other contacts.

Consider hiring a private investigator to perform a few searches on the buyer or the company, depending on the sensitivity of the information you are sharing. An experienced P.I. is resourceful, with access to databases and other resources, and may be able to quickly identify someone with a less-than-pristine reputation.

Ask your attorney to search public records to discover how many times they have been involved in litigation, if at all.

Checking a potential buyer’s credit — either business or personal — may also be wise.

Obtaining detailed financial information to verify 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.

For example, if the buyer makes questionable claims regarding several of their past acquisitions, ask to speak with the owner of a company they acquired. This request is certainly within your rights, especially if the buyer is asking for highly sensitive information.

Release Information in Phases

Release information to the buyer in stages, as the buyer demonstrates continued interest in your business. In this manner, you release more sensitive information as you gain the knowledge and trust of the buyer.

For example, you should release highly confidential information (e.g., customer contracts, etc.) only at later stages of due diligence.

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

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 that 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

Let’s clarify what information is regularly shared with buyers.

Information that is regularly shared with buyers:

• Financial & Tax
  • 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/collateral
  • Copies of licenses, permits, certificates, registrations, etc.

Information that is sometimes shared with buyers:

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

Information that is NOT regularly shared with buyers:

• Software code
• Customer names — current and prospective
• Trade secrets

Mark or Stamp Documents ‘Confidential’

Stamp or watermark all documents “Confidential” before releasing them to the buyer. While this is not a requirement of most NDAs, it is 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

Appoint a neutral third party to perform due diligence on behalf of the buyer. In these cases, the third party would only serve to perform due diligence — they would not 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. 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.

Jointly retain a third-party CPA firm to perform financial due diligence if you must share sensitive financial information with a buyer.

There are always risks involved with sharing your sensitive business information during the sales process. But there are steps you can take to minimize that risk and still share the necessary information about your business with potential buyers.

Prepare a Custom or Buyer-Specific NDA

Goals of an NDA

Goal #1: Control behavior

The primary goal of the NDA is to prevent confidentiality breaches from occurring in the first place. If the terms of the NDA are clear, then this objective is likely to be achieved. Considering this objective, it is often helpful in smaller transactions to reiterate the confidential nature of the transaction to the buyer during the initial phone conversation or meeting.

It may also be counter-effective to draft an NDA that is overly complex. Unfortunately, some buyers do not thoroughly read the terms of the NDA and inappropriately assume that the language is all boilerplate. With this being the case, it helps to reiterate the importance of the NDA if you believe the competitor has not completed many acquisitions before and may not possess this knowledge.

If the buyer attempts to negotiate the language of the NDA, this can be a good sign. It can be an indication that the buyer closely monitors their commitments and intends to abide by them. Also, if the goal of the NDA is to control behavior, then it goes without saying that the language should be clear, concise, and devoid of legalese.

Goal #2: Offer a mechanism for litigation

If an NDA is violated, your primary option in most cases is to litigate. While you can deliberate for hours regarding the definition of confidential information, this won’t matter if the buyer does not understand the nuances of the language contained within the NDA. With that being said, we believe the primary goal of an NDA is to control and prevent the behavior. If the first objective to “control behavior” is achieved, litigation isn’t necessary. If controlling behavior is the goal, then the language of the NDA should be clear and understandable.

Now that we have explained the purpose of the NDA, let’s offer several tips on how to strengthen the NDA when dealing with direct competitors.

Prepare a Buyer-Specific NDA

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

Prepare a Separate NDA for Different Categories of Information

Separate NDAs can be prepared for different categories of confidential information, with the 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: buyer meets with key employees vs. if the buyer meets with key customers vs. if you share proprietary pricing with the buyer.

Customize the NDA

An NDA often has to be customized for certain types of buyers.

For example, we handle a wealthy private individual differently than we handle a direct competitor. We also manage private equity groups differently from competitors.

Our process is more stringent with competitors as these transactions represent more risk to the seller. The protection a non-disclosure agreement offers varies based on the language contained within the NDA. In middle-market transactions, the NDA is negotiated with most buyers, especially if the buyer is a potential competitor.

Topics in an NDA to handle differently with a competitor include:

• Is information that is 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 customers, suppliers, or employees. See tips below for when to introduce this language.
• No-Hire: The buyer agrees not to hire your employees, as opposed to not soliciting them.

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 do not sign the NDA, then the buyer should be held liable for any breaches made by their representatives.

The buyer should also disclose their representatives’ name 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. 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. However, the buyer may agree to this language in an NDA 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 the closing. If this is the case, it may be necessary to negotiate an NDA with the buyer before allowing such conversations to take place.

Clauses to Consider Modifying

Now that we’ve offered several tips, let’s discuss the specific language contained within the NDA.

Definition of Confidential Information: This is a commonly negotiated section. Many agreements broadly define confidential information and then make specific exclusions. This section should specifically address any confidential information that you are particularly concerned about.

Example:

“Confidential Information” means information about the Company and its Customers, Customer Prospects, and/or Vendors that is not generally known outside of the Company, which you will learn of in connection with your employment with the Company. Confidential Information may include, without limitation: (1) the terms of this Agreement, except as necessary to inform a subsequent employer of the restrictive covenants contained herein and/or your attorney, spouse, or professional tax advisor only on the condition that any subsequent disclosure by any such person shall be considered a disclosure by you and a violation of this Agreement; (2) the Company’s business policies, finances, and business plans; (3) the Company’s financial projections, including but not limited to, annual sales forecasts and targets and any computation(s) of the market share of Customers and/or Customer Prospects; (4) sales information relating to the Company’s product roll-outs; (5) customized software, marketing tools, and/or supplies that you will be provided access to by the Company and/or will create; (6) the identity of the Company’s Customers, Customer Prospects, and/or Vendors (including names, addresses, and telephone numbers of Customers, Customer Prospects, and/or Vendors); (7) any list(s) of the Company’s Customers, Customer Prospects, and/or Vendors; (8) the account terms and pricing upon which the Company obtains products and services from its Vendors; (9) the account terms and pricing of sales contracts between the Company and its Customers; (10) the proposed account terms and pricing of sales contracts between the Company and its Customer Prospects; (11) the names and addresses of the Company’s employees and other business contacts of the Company; and (12) the techniques, methods, and strategies by which the Company develops, manufactures, markets, distributes, and/or sells any of the products.

Definitions of Representatives: Many NDAs allow the buyer to share sensitive information with their “representatives” without your explicit consent, and some agreements do not define what a representative is. We don’t recommend this.

The NDA should require that the buyer obtain the seller’s consent before releasing the confidential information to third parties. The agreement should also define what a representative is.

Example:

For purposes of this agreement, the term “Representatives” shall mean your affiliates and you and your affiliates’ respective directors, officers, employees, agents, and advisors (including you and your affiliates’ financial advisors, attorneys, accountants, and other consultants); [provided that any such advisors shall not also be, or at any time in the future become, a co-bidder or source of equity or debt financing].

Permitted Uses: The NDA should state that the confidential information can only be used for purposes of evaluating the transaction and for no other purpose.

Example:

The Receiving Party hereby agrees that the Evaluation Material will be used by it or its Representatives solely for the purpose of evaluating a possible Transaction and not for any other purpose, including in any way detrimental to the Disclosing Party, and will not be disclosed by the Receiving Party and its Representatives to any other person; provided, however, that any of such information may be disclosed to the Receiving Party’s Representatives who need to know such information for the purpose of evaluating any such Transaction and who agree to keep such information confidential and to be bound by this agreement to the same extent as if they were parties hereto. The Receiving Party will be responsible for any breach of this agreement by its Representatives and agrees to take at its sole expense all reasonable measures to restrain its Representatives from prohibited or unauthorized disclosure or use of the Evaluation Material.

Disclosures Required by Law: Most NDAs allow the buyer to release confidential information if compelled to do so by law. Strongly worded (on behalf of the seller) NDAs allow the seller to mediate these claims and otherwise offer the seller several protective mechanisms before the information is released.

Example:

In the event that the Receiving Party or any of its Representatives is required, based on the written opinion of the Receiving Party’s outside legal counsel, to disclose all or any part of the information contained in the Evaluation Material under the terms of a valid and effective subpoena or order issued by a court, governmental body of competent jurisdiction or stock exchange, the Receiving Party agrees to immediately notify the Disclosing Party of the existence, terms, and circumstances surrounding such a request, so that it may seek an appropriate protective order and/or waive the Receiving Party’s compliance with the provisions of this agreement (and, if the Disclosing Party seeks such an order, to provide such cooperation as the Disclosing Party shall reasonably request at the Disclosing Party’s expense). In the event that such protective order or other protection is denied and that Receiving Party or any of its Representatives are nonetheless legally compelled to disclose such information, it or its Representatives, as the case may be, will furnish only that portion of the Evaluation Material that Receiving Party’s outside legal counsel advises it in a written opinion is legally required and will exercise all best efforts to preserve the confidentiality of the remainder of the Evaluation Material. In no event will the Receiving Party or any of its Representatives oppose action by the Disclosing Party to obtain a protective order or other relief to prevent the disclosure of the Evaluation Material or to obtain reliable assurance that confidential treatment will be afforded the Evaluation Material.

Return or Destruction of Information: The NDA requires the buyer to return or destroy the information if they decide not to pursue this transaction, although this clause is often irrelevant given the current state of technology.

Access to Employees: This is a hotly debated topic. All NDAs should restrict access to employees in the early phases of the transaction. If you wish to grant access to your employees, we highly recommend having your attorney draft a non-disclosure that addresses non-solicitation of your employees before you allow the buyer to meet with your employees.

Example:

Without the prior written consent of the Company [or the Company’s investment bank], neither you nor any of your Representatives will initiate or cause to be initiated (other than through a financial advisor designated by the Company) any (a) communication concerning the Evaluation Material; (b) requests for meetings with management in connection with a potential Transaction; or (c) communication relating to the business of the Company or any of its affiliates or a potential Transaction, in each case with any officer, director or employee of the Company or any of its affiliates.

Non-Solicitation of Customers, Employees, Suppliers: This is also a hotly debated section and some buyers may refuse to sign an NDA that contains this language in the earlier stages of the transaction.

You can soften this by stating that the buyer agrees to not actively pursue your employees but that your employees can be hired if they apply through general employment advertisements.

Example:

For a period of three years from the date hereof, the Receiving Party agrees that, without the prior written consent of the Company, it and its affiliates will not directly or indirectly hire or solicit any current employee of the Company; provided, however, that the foregoing shall not apply to generalized searches for employees by use of advertisements in the media that are not targeted at employees of Seller.

No Obligation to Proceed: The NDA should state that the parties have no obligation to proceed and that the parties do not intend to create a binding commitment.

Disclaimer Regarding Accuracy: To protect the seller, the NDA should state that the seller is not making any warranties regarding the accuracy of the information.

Example:

The Receiving Party understands that neither the Disclosing Party nor any of its Representatives has made or makes any express or implied representation or warranty as to the accuracy or completeness of the Evaluation Material. The Receiving Party agrees that, except for any breach of this Agreement, neither the Disclosing Party nor its Representatives shall have any liability to the Receiving Party or any of its Representatives or stockholders (or other equity holders) on any basis (including, without limitation, in contract, tort, under federal or state securities laws or otherwise), and neither the Receiving Party nor its Representatives will make any claims whatsoever against such other persons, with respect to or arising out of: a possible Transaction, as a result of this Agreement or any other written or oral expression with respect to a possible Transaction; the participation of such party and its Representatives in evaluating a possible Transaction; the review of or use of content of the Evaluation Material or any errors therein or omissions therefrom; or any action taken or any inaction occurring in reliance on the Evaluation Material, except and solely to the extent as may be included in any definitive agreement with respect to any Transaction.

Term: All NDAs should include a term. Most NDAs contain a term of two to three years. Go for the longest term you can get away with.

Choice of Law: We recommend choosing your home state.

Injunctive Relief: The NDA should specifically allow the seller to obtain an injunction in the event of immediate damage.

Assignment: Most NDAs are not assignable, and the NDA should clearly state this.

Summary

If you are contacted by a competitor, we recommend the following:

• Contact buyers based on increasing stages of risk
• Ask your attorney to prepare a custom or buyer-specific NDA
• Thoroughly screen the buyer
• Release information to the competitor in stages or phases
• Stamp documents “confidential”
• Appoint a neutral third party to facilitate due diligence
• Ask your attorney to prepare a specific non-disclosure agreement for your competitor
• Ensure the buyer’s representatives also sign a non-disclosure agreement
• Ask the buyer to sign additional non-disclosure agreements as the transaction progresses