By Irvin Brum, Esq.
Selling a business can be an emotionally trying time, fraught with demons both real and imagined. Near the top of the nightmare list is the fear that information about an impending sale will be leaked prematurely to employees and business partners, jeopardizing long-standing relationships and causing defections that can both kill a deal and seriously damage the business itself. Of equal concern to business owners is the risk that critical information shared with potential buyers during the due diligence process will be used for competitive advantage if the transaction fails to close.
While a well drafted confidentiality agreement can be effective in maintaining the confidentiality of a proposed sale, there are a number of steps that business owners can take to reduce the likelihood of an inadvertent disclosure. First, buyers should be pre-screened so as to limit the number of suitors to those most likely to make a serious offer. Using an investment bank or business broker can greatly assist in qualifying potential buyers while reducing dependence on employees in the due diligence and negotiation process. Second, to the extent that non-management employees are needed to facilitate the sale, their loyalty and discretion can be significantly enhanced by appropriate compensation arrangements that help allay their concerns about the future while aligning their interests with those of the business owners. Finally, because many buyers including public companies and private equity funds typically require that the companies they buy have audited financial statements, forward-thinking owners will start having their financial statements audited well before the first buyer walks through the door. This will help facilitate a sale without raising questions among employees who might otherwise suddenly witness a number of unfamiliar faces appearing at the company poring through the company’s books and records for no obvious reason.
While a seller may succeed for a time in keeping knowledge of the sale private, sooner or later, employees, customers and suppliers will need to be notified. A wide variety of factors will influence the timing of the disclosure, including whether the buyer insists on contacting key employees, customers and suppliers as part of its due diligence investigation, the existence of anti-assignment or change of control provisions in significant contracts, the need to negotiate with other third-party constituencies, (e.g., unions and lenders), the extent of sale rumors in the company and the industry, and whether and when federal securities laws will require the buyer to publicly disclose the transaction.
From a seller’s prospective, the goal is almost always to delay the disclosure until the buyer is “locked in” with a binding contract. But a cautious buyer that has not been given the opportunity to contact key employees, customers and suppliers before the contract is signed may condition its obligation to close the acquisition on its ability to retain these relationships after the closing for its own benefit. The issue of who bears the risk of lost relationships after the deal is announced is often hotly negotiated between buyers and sellers.
To protect the confidentiality of proprietary information, information can and should be disclosed in stages with more sensitive information not shared until late in the process. For example, although a buyer may at some point be entitled to know the seller’s gross profit margins for specific customers, there may be no reason to disclose the actual names of those customers until the closing. Poorly advised and inexperienced sellers often divulge more information too early in the sale process than is needed.
Sellers, of course, rely most heavily on confidentiality agreements to protect their interests. From a seller’s perspective, this agreement should describe confidential information in the broadest possible terms and apply to all information provided in any format – i.e. oral, written, digital or otherwise. Among the issues to be negotiated are the length of time the agreement will remain in effect, whether a buyer must obtain separate confidentiality agreements from its agents and advisors before sharing seller’s confidential information, and how to ensure the return or destruction of information when a transaction fails to close.
Unfortunately, sellers trying to economize on legal fees often either accept a buyer’s “standard form” or use a form previously used by seller in another context. Sellers without the benefit of experienced M&A counsel risk irreparable harm as proprietary information is lost to those who will use it for their competitive advantage. Such sellers also lose the opportunity of negotiating for less common but sometimes necessary protection – e.g., restrictions on the suitor’s ability to hire seller’s employees if the deal does not close. In a recent sale transaction involving direct competitors, we successfully negotiated on behalf of the seller for the inclusion of a “standstill” provision that required the potential buyer to pay seller if, at any time during the negotiations or six months after negotiations terminated, seller lost a key customer to the buyer, whether or not the loss resulted from the misuse of confidential information.
While the sale of a business will always involve challenges and risks, advance planning, careful thought and professional advice can mitigate those associated with confidentiality and prevent a successful business from becoming damaged goods.
Irvin Brum, Esq.