In the previous post in our series on the process of buying or selling a business, we focused on providing an overview of the process. In this second post, we will provide an in-depth analysis of the non-disclosure agreement (an “NDA”; sometimes referred to as a confidentiality agreement) that is negotiated and entered into between a potential buyer and seller.
Basics of an NDA
An NDA is a binding agreement between a potential buyer and seller separate from the letter of intent or term sheet. In an NDA, each party agrees to certain confidentiality restrictions being placed on the information to be shared between the parties, such as trade secrets, customer and supplier lists, financial statements, etc. An NDA can either be one-sided (i.e., protective of the information shared by the potential seller) or mutual (i.e., protective of the information shared by both the potential seller and the potential buyer). A mutual NDA is typically entered into when the potential buyer intends to share sensitive or proprietary information with the potential seller or when the potential buyer intends to issue equity to the potential seller. The remainder of this blog post will be dedicated to primarily examining a unilateral NDA from the potential seller’s perspective.
Typically, an NDA is more important to a potential seller, as it is usually the party sharing most, if not all, of the sensitive information. If a potential seller discloses information to a potential buyer prior to entering into an NDA, such information could be at risk of not being protected by confidentiality restrictions. Therefore, the potential seller should aim to sign an NDA before disclosing any information to the potential buyer; however, if the parties do not, then the potential seller should draft the NDA to ensure that it protects information disclosed prior to the execution of the NDA.
Information Covered and Exceptions
Defining what information is covered by the NDA is a balancing act. The potential seller’s initial inclination will likely to be as broad and comprehensive as possible. While this can have some advantages, oftentimes, being more specific about what is covered can result in a better outcome if there is a breach of the NDA by the potential buyer. Typically, the potential seller will want to include specific types of information, such as customer and supplier information, financial information, forecasts, studies, analyses, presentations, records and reports, and any underlying notes or preparation materials created in anticipation of the transaction. Additionally, the NDA should seek to include as confidential information that the parties are contemplating and discussing a potential transaction and the actual terms of such transaction. The potential seller should also aim to make it clear that information shall remain confidential regardless of whether it is shared orally, electronically, in written format, or by any other means and that such shared information need not be marked “confidential” for it to be subject to the NDA.
There are four typical exceptions to information covered by NDAs that the potential seller should be aware of and not be frightened by in negotiations:
- Information that is or becomes known to the public;
- Information that was already known by or in the possession of the potential buyer;
- Information that becomes available to the potential buyer; and
- Information that was or is independently developed by the potential buyer.
While these are common exceptions, the potential seller should seek to limit the scope of these exceptions as much as possible by including various common qualifiers suggested by the potential seller’s attorney.
Use of Information and Exceptions
The terms of the NDA should make it clear that the potential buyer can only use the potential seller’s confidential information for the purposes of evaluating a potential transaction between the parties. The NDA should also clearly state that the potential buyer may not use the confidential information for any other reason, including but not limited to its own competitive purposes. It is also important that the potential seller include specific language regarding with whom the potential buyer may share confidential information. Ideally, the potential seller should seek to limit the sharing of confidential information to those persons who have a need to know the confidential information to assist the potential buyer in its evaluation of the potential transaction.
A common exception to the use restrictions included in an NDA are disclosures required by law, regulation, or legal or regulatory request. Oftentimes, the potential buyer will want the ability to share the potential seller’s confidential information without liability if required by a court order or other legal requirement. This exception is typically included in an NDA, but the potential seller should seek to include additional protections for these circumstances. For example, prior notification by the potential buyer to the potential seller before any disclosure and the cooperation of the potential buyer in aiming to maintain the confidential nature of such information.
Another exception often requested by the potential buyer is the ability to disclose confidential information to a lending or financing source in order for the potential buyer to secure financing for the potential transaction. In response to this type of inclusion, the potential seller should push for language that this type of disclosure requires the prior written consent of the potential seller.
The term of an NDA can be indefinite, or it can continue until a certain date or event. The potential seller should always favor and push for an indefinite term, but the potential buyer is likely to push back. The term of an NDA is typically not indefinite but is instead somewhere between 1 and 3 years in length. If the parties agree to a term that terminates upon a certain date or event, the potential seller should make sure to include that any confidential information that constitutes a trade secret is protected by the NDA until it loses its trade secret protection, if ever.
The potential seller should seek to include a provision that clearly states the potential seller’s intention to protect the attorney-client privilege, which covers some of the confidential information that may be shared with the potential buyer. This provision should state that the potential seller is not waiving any rights to attorney-client privilege that might apply to the confidential information shared with the potential buyer.
An NDA commonly has two types of remedies: (1) equitable relief and (2) monetary damages. The potential seller will want to push for equitable relief language to be included because monetary damages may be insufficient to cover the full losses, and the potential seller will want to stop the potential buyer from further disclosure of confidential information. If the NDA does not include equitable relief language, the potential seller could face tremendous risk, including losing their entire business. Occasionally, the potential seller can be more aggressive by including an indemnity provision that provides that the potential buyer will cover all of the costs associated with the enforcement of the NDA, but the potential buyer is likely to push back on this heavily.
While an NDA is the best a potential seller can do contractually to protect their confidential information, NDAs can be difficult and expensive to enforce. Therefore, even when there is an NDA in place between a potential buyer and a potential seller, the potential seller should be cautious in disclosing their most sensitive and important information (for example, the potential seller’s customer names could be highly sensitive for some businesses) until the potential seller is reasonably confident that the potential transaction is going to go through.
We see that clients who understand the deal process are more confident, less overwhelmed, and get better terms. Having skilled advisors on your team can help you run a successful deal. The mergers and acquisitions practice group at Riggs Davie PLC counsels clients through deals on the buy-side and sell-side in a wide range of industries, including technology, health care, health tech, fintech, professional services, financial services, real estate, business services, manufacturing, and distribution. For more information about our services, please visit www.riggsdavie.com or contact our practice group by email at email@example.com.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.