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Keeping Things Confidential: How to Protect Sensitive Information in an M&A Deal – The Middle Market Deal Corner
Keeping Things Confidential: How to Protect Sensitive Information in an M&A Deal – The Middle Market Deal Corner

As a business owner considering a sale, there is a laundry list of things that might keep you up at night, and confidentiality is likely at or near the top of that list. A business has many different critical parties who may be concerned about the fact that the ownership is pursuing a sale, including employees, customers, and suppliers. At what point do you make them aware that a transaction is taking place?

Exploring a deal with a potential buyer will also inevitably require the Seller to share the Company’s sensitive/confidential information. What happens when a deal falls through (which, unfortunately, is not an unusual occurrence for a variety of reasons) and the potential buyer is now in possession of the Company’s confidential information? These concerns can have a major impact on the viability of a deal and on the go-forward success of the Company.

Internal Confidentiality Concerns: Finding the Right Balance

For many sellers, their greatest fear is that news of a potential transaction will leak to their employees in the middle of a sale process. Employees are often nervous when they learn that their employer’s ownership is changing hands; however, it is important to balance this concern against the reality that a sale process will naturally need to involve different members of a company’s management team. As a sale progresses, even the most hands-on business owner is unlikely to be able to provide the detailed information that a buyer will seek in due diligence without involving other members of the management team, not to mention the sometimes overwhelming amount of work that reviewing/responding to diligence requests can entail.  

The key for a business owner is to determine the right group of people to bring “under the tent” in the earlier stages of the deal process. Who are the most trusted members of senior management that have access to the Company’s sensitive data, customer relationships, and contracts? If you were a buyer of the business, who are the key employees that you would want to stay on board and help run the Company under new ownership?

One tool to help incentivize these selected members of the management team to assist with a deal process is a transaction or retention bonus. This is a bonus, oftentimes coupled with a deal-specific non-disclosure agreement, that is offered to certain members of the management team and is payable contingent on remaining with the Company either through the closing of the sale or for a specified period thereafter (the latter option being preferable to a potential buyer). Such a bonus is almost always payable by the Seller as a transaction expense at closing; but, if structured correctly, it can ensure that the management team is focused and engaged in completing the deal, as well as providing the Buyer confidence that the management team will be retained through or after the closing. 

The last internal group to consider is the broader group of the Company’s employees beyond the management team. For all but the smallest companies, these employees will typically not learn about the deal until after a closing has occurred. The Buyer will likely require input and control into how the transaction is announced to the employees, as the Buyer will want to carefully craft a communication strategy to ensure that the message is well received and encourages retention.  

External Facing Concerns: Announcing to Customers and Suppliers 

The Seller is also likely worried about how to announce a transaction to the Company’s key business relationships, such as major customers and key suppliers. Whether any customers/suppliers find out about a transaction before closing is influenced by a number of factors, particularly the degree to which the Buyer wants to diligence such customer and supplier relationships prior to closing the deal. Some acquirers may ask for customer diligence calls where the Buyer’s team will speak with a certain subset of top customers to confirm that the relationships are strong and will continue into the future.

As a Seller, it is important to develop a plan for such calls, both to help sell the customer that the Buyer will be a good fit for the business and to demonstrate to the Buyer that the Company’s customer relationships are well entrenched. Again, this is a situation where it can pay dividends for the Seller to have a management team that is involved and engaged in the deal process. Generally, the Seller will want to hold off allowing customer calls until later in the diligence process when the parties are reasonably comfortable that the deal will be completed.

The Key: Non-Disclosure Agreement

The Buyer’s due diligence review will be detailed and thorough – the Seller should expect to answer questions and provide data on financial history, customers, suppliers, intellectual property, past litigation, employees, and employee benefits. In most cases, the potential Buyer may be either an existing competitor or a private equity investor that is interested in entering the space.

The most important protection for the Seller to explore a potential transaction without jeopardizing the Company’s sensitive information is a well-drafted nondisclosure agreement. Such nondisclosure agreements should be specifically crafted for a transaction and will be more detailed than the typical confidentiality provision found in commercial agreements or other business arrangements.        

A good transaction-specific nondisclosure agreement (NDA) covers the following key areas:

  1. Confidential Information: From the Seller’s perspective, the nondisclosure agreement should include a broad definition of what constitutes “confidential information,” including information shared in any format and regardless of whether the information is actually labeled as confidential. Confidential information should include the fact that the parties are exploring a deal and any terms of such a deal. The definition should also pick up any work product created by the Buyer or its representatives that incorporates or is based on any confidential information.
  2. Nondisclosure/Non-Use: It is important that the nondisclosure agreement prevents both the use and/or disclosure of any confidential information. The parties should also carefully consider to whom the nondisclosure agreement will apply and how the applicability of the agreement may be enforced. It is typical for NDAs to allow disclosure to the parties' “representatives” who need to know such information in order for the parties to evaluate a deal. A well-drafted NDA will hold a party responsible for any breach of the agreement by their representatives.
  3. Contact With Customers/Suppliers: The Seller will want the Buyer to refrain from contacting any of the Seller’s customers, suppliers, or other key third parties until the transaction has progressed far enough to have a reasonable chance of being completed. The Buyer will often push for a carveout for contact in the “ordinary course of business,” which the Seller must be careful to limit appropriately, particularly where the Buyer may be a direct competitor. The Seller should maintain tight control over when and how a potential Buyer reaches out to third parties that are important to the success of the business.
  4. Non-Solicitation: Employees are often one of the most valuable assets of a business. In some industries, particular employees may be critical to the future success of the business and possess important information about strategy, customers, and business plans. Accordingly, the Seller should consider a non-solicitation provision that, at a minimum, prevents the Buyer from soliciting or hiring key members of the Company’s management team or any employee to whom the Buyer is introduced in the process of exploring a transaction.
  5. Destruction/Return of Information: If the parties ultimately decide to walk away from a deal, the nondisclosure agreement should provide for the return or destruction of any confidential information.
  6. Clear Delineation of Rights: The parties are sharing information for the sole purpose of exploring a transaction, and the NDA should specify that the Seller is not granting any rights or licenses to the Buyer in connection with the provision of information. Further, the Seller is not providing any representations or warranties as to the accuracy or completeness of the information being shared.
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