Non-Disclosure Agreements for Selling a Business
September 17, 2021
September 17, 2021
Your hard work may pay off, and a potential buyer is interested in purchasing your business. You may even have high-powered private equity firms or large companies interested in the opportunity. That is exciting, but you must protect your business in the event the sale does not go through.
Say your business makes the best bread in the world. Everyone who tastes it is in awe, so a private equity firm wants to buy the business. Unfortunately, after due diligence (which includes reviewing your bread making methods) your price is too high, and the private equity firm instead buys some other bakery. Shortly thereafter, backed by private equity money, that bakery starts mass producing your bread. It turns out you gave the private equity firm your recipe and the legal right to disclose it. Such is the importance of the non-disclosure agreement.
What is a non-disclosure agreement?
Sophisticated potential buyers expect to enter a non-disclosure agreement (NDA), also called a Confidential Information Non-Disclosure Agreement (CINDA), with the seller. The NDA protects confidential information from disclosure, either indefinitely or for a certain time.
Why enter a non-disclosure agreement?
People who understand business know that success is based on formulas, methods, and other processes unknown to competitors. Should this information become public, the successful business will lose its competitive edge. Further, a buyer who consummates an acquisition will expect that any other potential purchasers will not have an opportunity to use the information learned in due diligence to set up a similar business.
While most potential purchasers are honorable, unscrupulous people exist in every profession. The NDA protects your business against unethical potential purchasers.
Who Has the Advantage in Negotiating the NDA?
You have probably heard that “a man who is his own lawyer has a fool for a client.” This is particularly true with an NDA, a document that can doom the business you built to failure. Remember, a sophisticated potential purchaser enters hundreds if not thousands of NDAs every year, each reviewed by an attorney. You are at a substantial disadvantage in negotiating the NDA. Further, most sell-side attorneys are at a substantial disadvantage in negotiating NDAs because there are law firms whose entire practice is drafting and negotiating buy-side NDAs.
The big advantage you have is that, prior to entering the NDA, the buy side has no idea what secrets make your business successful. As a result, you know what information is vitally important to protect, and can work with your attorney to make sure that information is either not disclosed initially or is fully and permanently protected in the event of a disclosure.
Starting the NDA Process
You should not start blindly negotiating an NDA, nor should you sign the NDA the potential buyer supplies you. Instead, your lawyer should draft an NDA tailored to your business after asking you the following questions:
As an example, say you own a restaurant. It is obviously successful because it is always packed. That’s why the private equity buyers are interested. But the potential buyer does not know that your number one seller is the Spicy Burger, and, while it is obvious from the menu that the Spicy Burger has a secret sauce, only you know what is in the secret sauce. You also know that the reason the Spicy Burger sells is because of that secret sauce.
If your competitors knew that you currently make most of your revenue off the Spicy Burger, that would be bad for your business – they might try and make their own not-as-good version of the Spicy Burger. But if that information was released two years later, it might not be that interesting. By contrast, the ingredients in the secret sauce can never be disclosed, or any restaurant could make an exact copy of the Spicy Burger.
And that means never ever. Giving your friends and relatives the recipe to the secret sauce absent an NDA could be fatal to your claim that the secret sauce is in fact, a secret.
Potential buyers will ask for unique provisions based on their business model. If the potential buyer makes many investments and owns numerous portfolio companies, it will ask for provisions that allow those investments to take place and be managed. If the potential buyer is in your space, it will require an acknowledgment that in the future it may acquire businesses that compete with you. Both these provisions are acceptable but need to contain restrictions against using your confidential information in pursuing these opportunities.
Most potential buyers also expect that the NDA will terminate after 1-3 years, meaning no more confidentiality obligations will apply. This is generally acceptable, but you may need to carve out certain information from the termination, or, alternatively, make clear that certain information (the secret sauce) will not be disclosed during due diligence absent a much more restrictive agreement protecting it.
Finally, remember that the other side is a potential customer. Your attorney needs to be courteous and responsive. That does not mean giving in to every demand. It means immediately responding to the potential buyer’s communications, listening to the potential buyer’s concerns, accepting changes when possible but adding needed modifications, and treating the potential buyer’s counsel with respect.
Your potential buyer typically looks at hundreds of possible acquisitions each year. Almost every buy-side investor can tell you countless stories of a seller’s obnoxious attorney needlessly blowing up a deal that would have made the seller wealthy. Every investor knows it is the seller’s attorney’s job to protect the seller, but that can be done in a reasonable and courteous manner that makes the potential buyer more interested in the transaction.