Non-Disclosure Agreement (NDA) | A Complete Guide for M&A

Safeguarding confidentiality takes center stage when you’re in the process of selling your business. A well-crafted non-disclosure agreement (NDA) addresses a host of critical matters, including non-solicitation and various aspects of the sales process. While it might be tempting to regard all NDAs as standard, any missteps during the negotiation and execution of an NDA can potentially limit your future options. In extreme cases, breaches can even spell disaster for your business.

Moreover, a properly drafted confidentiality agreement serves as a means to establish expectations and convey to potential buyers that you are well-prepared and professionally represented. This, in turn, deters buyers from employing fruitless negotiation tactics on a seller who possesses a sophisticated approach to the process.

In the realm of M&A transactions, the execution of a confidentiality agreement (CA) is virtually standard practice. However, it’s important to recognize that a CA is just one tool among many at your disposal for upholding confidentiality throughout the sale process. This article delves into strategies that can be employed in conjunction with a meticulously crafted CA, both before and during the sale, to exercise a high degree of control over your sensitive information.

The insights shared in this article hold particular relevance if the terms of a confidentiality agreement are pivotal to the sale of your business, especially when dealing with direct competitors, which carries inherent risks.

Furthermore, this article serves as an invaluable primer for any professional advisor, such as an accountant or attorney, seeking a comprehensive understanding of the role of CAs in the broader context of the sales process, along with the intricate nuances of NDA negotiations.

If you’re on the verge of listing your business for sale, consider this article essential reading.

Topics Covered in a Non-Disclosure Agreement

An NDA typically includes the following essential components:

• Definition of confidential information
• Usage restrictions on confidential information
• Obligations imposed on the recipient
• Standards of care
• Duration of the agreement
• Remedies in case of breach
• Permitted disclosures
• Procedures for returning confidential information
• Disclosure period
• No obligation to proceed
• No grant of intellectual property rights
• Enforcement mechanisms
• Applicable laws and jurisdiction
• Dispute resolution process

Regarding the handling of confidential information, the buyer commits to:

• Using the information solely for the purposes outlined in the agreement.
• Disclosing the information only to individuals with a legitimate need to access it for evaluating the transaction.
• Employing reasonable efforts to maintain the information’s security.
• Ensuring that any parties receiving the information adhere to obligations restricting its use, disclosure, and security at a level at least as stringent as defined in the agreement.
• Not sharing the information with third parties, unless mandated by law, and retaining it for a specified period, usually ranging from one to five years.
• Safeguarding the received information with precautions at least as robust as those used for protecting their own data.
• Refraining from reverse engineering or decompiling the information.
• Promptly informing the disclosing party of any breaches or unauthorized disclosures.
• Adhering to all relevant government rules and regulations, including export and import laws.
• Discontinuing the use of the information and returning it to the disclosing party upon termination of the NDA.

The Importance of a Properly Drafted NDA

It can be tempting to perceive all NDAs, or Confidentiality Agreements (CAs), as standard boilerplate documents. However, the reality is that even the slightest oversight during the negotiation and execution of a non-disclosure agreement can have far-reaching consequences in the later stages of the process. In some unfortunate instances, a breach of confidentiality can even jeopardize the very existence of your business.

Over the years, the language employed in M&A confidentiality agreements has evolved significantly, extending beyond mere confidentiality clauses. Contrary to what the name may imply, these agreements now encompass a broad array of critical issues, including non-solicitation and other intricacies of the sales process.

A well-crafted confidentiality agreement not only safeguards your sensitive information but also serves as a means to establish clear expectations with potential buyers—an invaluable element in the M&A process. Such a meticulously prepared agreement also communicates to buyers that you are well-represented, deterring them from employing negotiation tactics that are unlikely to succeed with a sophisticated, properly represented seller.

In cases where you are represented by an investment banker or M&A advisor, they will typically have a template at their disposal. Given that most M&A advisors primarily represent sellers, their templates are typically seller-friendly.

If your circumstances are unique, it’s advisable to consult with your attorney to draft a custom NDA. While most buyers may not make extensive requests regarding the agreement’s language, you should be prepared to engage in negotiations as requests vary.

In practice, it’s often the disclosing party, typically the seller in M&A transactions, who drafts most NDAs. Sellers frequently engage with multiple buyers, and employing consistent language across agreements streamlines the process. It’s important to note that a significant portion of NDAs seldom progress beyond the initial stage of selling a business (i.e., signing an NDA and reviewing the offering memorandum), and it’s not uncommon to execute numerous non-disclosure agreements with potential buyers throughout the sale process.

The Process

In middle market transactions, it’s common practice for intermediaries to initially provide a teaser profile to potential buyers before requesting the signing of a non-disclosure agreement (NDA). Many middle market buyers prefer to gauge the suitability of a business before committing to the terms of an NDA.

Typically, both the teaser profile and the NDA are included within the same document. Buyers are invited to endorse the NDA if they wish to gain access to the Confidential Information Memorandum (CIM) containing sensitive business details. Given the pivotal role this document plays in advancing the process, the non-disclosure agreement is typically executed early on in the proceedings.

When to Execute a Confidentiality Agreement or NDA

The non-disclosure agreement (NDA) takes the lead as the inaugural document in a transaction, setting the stage for negotiations and establishing itself as a pivotal cornerstone in the sales process. Depending on the nature of the business at hand, disclosing the business’s name and location can be an exceptionally sensitive matter. Sellers often seek to safeguard this information until they are confident in the authenticity and sincerity of the potential buyer.

The primary objective of the intermediary representing the seller is twofold: safeguarding their client’s confidential information while furnishing adequate details to enable the potential buyer to make an informed decision about pursuing the business. This, without a doubt, requires a finely tuned balancing act.

In cases where the business is being brokered or represented by an M&A intermediary, the execution of the NDA typically precedes the disclosure of the business’s name. Conversely, if the owner has been directly approached by a competitor, it’s commonplace for an NDA to be executed prior to engaging in substantive discussions or sharing confidential information with the buyer.

What are the Benefits of Signing an NDA for a Buyer?

While some buyers may initially perceive a Non-Disclosure Agreement (NDA) as favoring the seller, it’s crucial to recognize that the NDA serves the interests of both parties involved. Although the seller benefits from confidentiality protections, the buyer also gains significant advantages through the NDA. Even prospective buyers who ultimately decide not to purchase the business, including potential competitors, are required to sign an NDA before accessing sensitive company information.

Consider this: The mere revelation that a business is up for sale can trigger reevaluations from key customers or stakeholders. In such cases, a non-disclosure agreement plays a pivotal role in averting potential disruptions and aligns with the buyer’s interests as well.

By affixing their signature to the NDA, the buyer effectively signals their serious intent to acquire the business. It’s important to note that a seller is typically hesitant to divulge highly confidential and critical information without the assurance of a signed NDA. In fact, most sellers are unwilling to progress to further discussions with a buyer who is unwilling to commit to a confidentiality agreement. The seller’s willingness to cooperate often mirrors the buyer’s level of cooperation, emphasizing the symbiotic nature of this essential document in the negotiation process.

Types of NDAs

There exist two fundamental types of NDAs—unilateral and mutual. While many NDAs may not explicitly state their nature, a brief perusal of the contract can help differentiate between the two.

• Unilateral: In a unilateral, or one-way agreement, only one party bears the obligation to safeguard and not disclose confidential information. The majority of NDAs in the context of business sales fall under this category. Here, the buyer assumes the role of the recipient, while the seller acts as the disclosing party, with no reciprocal confidentiality obligations.
• Mutual: Conversely, a bilateral, or mutual agreement, involves both parties sharing information that must remain confidential. This form of agreement commonly arises when businesses contemplate joint ventures or mergers.

Differences in NDAs by Type of Buyer

As a customary practice, almost all private equity firms willingly agree to execute a non-disclosure agreement (NDA).

Conversely, venture capitalists, who operate as financial buyers in the realm of speculative opportunities, typically exhibit reluctance when it comes to signing NDAs. Their hesitation stems from the heightened risk that signing an NDA might entail. It could potentially lead to accusations of trade secret misappropriation should the venture capitalist (VC) independently develop similar information in the future or inadvertently disclose or utilize the shared information. This central concern is the primary rationale behind the reluctance of VCs to commit to NDAs.

Content & Analysis of NDA Language

The guide below, while not exhaustive in its coverage, delves into the prevalent issues that typically surface during the process of drafting and negotiating a confidentiality agreement.

Introductory Paragraph

Most confidentiality agreements commence with an introductory paragraph, a section of paramount importance that should not be overlooked. Here’s a breakdown of the key elements within this paragraph:

[Keywords emphasized for clarity] “This Agreement is established and entered into by the undersigned, acting both in an individual capacity and as a representative of their business entity, encompassing its officers, directors, partners, shareholders, employees, brokers, agents, and advisors (collectively referred to as the ‘Buyer’), and the Seller. The Buyer has expressed the need for specific information to assess and explore the potential acquisition, which may involve the transfer of assets, stock, partnership interests, or other means, as well as potential mergers or joint ventures concerning all or part of the Seller’s interests (referred to as the ‘Transaction’). Therefore, the parties concur as follows: The Buyer is obligated not to disclose any information related to the Seller, [except where legally mandated], regardless of whether it originates from the Seller or third parties acting on the Seller’s behalf. This obligation extends to information disclosed before, during, or after the effective duration of this Agreement. The Buyer may disclose such information solely to their employees, officers, advisors, or other affiliated individuals, strictly for the purpose of evaluating the Transaction. Furthermore, such recipients must have explicitly agreed in writing to adhere to the terms of this Agreement.”

Here are our observations:

• In the provided language, the Buyer is signatory to the non-disclosure agreement both in their individual capacity and as a representative of their entity. It’s worth noting that some Buyers may seek to strike “individually” to limit personal liability, which is a reasonable request, particularly for financial Buyers like private equity groups. However, this request might be deemed unreasonable when the Buyer is a small, privately-owned business with a single owner. In such cases, ensuring that the Buyer signs the NDA on behalf of their entity and personally is advisable.
• The NDA explicitly confines the Buyer to using the disclosed information exclusively for the purpose of evaluating the potential Transaction. The inclusion of the term “possible” is deliberate, as it avoids implying any commitment between the parties until a formal written agreement is in place.
• The introductory paragraph effectively broadens the scope of the NDA in two key aspects:

1) Involvement: It extends the reach of the NDA to include reference to “third parties,” and
2) Timeframe: It encompasses information disclosed before the NDA’s execution, during its term, or even after its expiration.

Definition of Confidential Information

The definition of confidential information typically takes center stage within a non-disclosure agreement (NDA), often nestled in the initial paragraphs and going by various names like “Definition of Evaluation Material,” “Confidential Information,” or simply “Information.”

The seller’s strategic objective revolves around framing the scope of confidential information as expansively as possible. This is achieved by broadly defining it and then explicitly cataloging exclusions in a separate section, commonly labeled “Exclusions from Confidential Information.” Sellers aim to encompass a wide spectrum, considering information:

• Conveyed verbally or in any form.
• Regardless of the disclosing party.
• Transmitted at any time, whether before or after the agreement’s execution.
• Including information “derived” from the original confidential information, such as analyses, forecasts, or other amalgamations.

In contrast, buyers employ tactics to narrow down this definition. They often employ the phrase “to the extent” to avoid categorizing entire documents as “confidential information” simply because they contain a solitary piece of confidential content. Alternatively, buyers may favor a more restrictive definition, excluding orally conveyed or third-party information, data acquired before the agreement’s execution, or mandating that the seller explicitly label information as “confidential.”

The buyer’s exposure to risk arising from an expansive “confidential information” definition is minimal, as the primary obligation is to maintain confidentiality. The potential for the seller to allege a breach and substantiate damages is limited, with the onus of proof resting on the seller to demonstrate that the buyer indeed disclosed confidential information. Consequently, in most instances, parties opt for an expansive definition but temper it through explicit exclusions.

The range of information that can fall under the umbrella of confidential information is notably extensive. It encompasses virtually any information exchanged between the parties: data, expertise, prototypes, engineering schematics, software, test results, tools, systems, and specifications, to name a few. This list is by no means exhaustive but serves to illustrate the vast array of items that can merit classification as confidential. Moreover, it’s essential to recognize that confidential information need not be confined to the written realm; it can encompass orally conveyed information as well.

The definition of confidential information sometimes becomes a focal point of negotiation. Sellers typically aim for a broader scope, encompassing “all information related to the seller, disclosed to the buyer.” Conversely, the receiving party, or buyer, may resist shouldering the weight of such a comprehensive definition and seek to narrow it down. They might even insist on the seller explicitly labeling content as “confidential.”

Another point of contention can be whether third-party confidential information should fall under the same confidentiality umbrella. The receiving party may strive to narrow the definition to avoid any “contamination” from such information. This can be achieved by:

• Restricting it to written disclosures or oral disclosures that are documented within a specified timeframe.
• Requiring the information to be explicitly marked as confidential.
• Detailing which information is deemed confidential.
• Specifying the dates of disclosure.

During the evaluation of confidential information, the buyer might generate reports or summaries based on the provided data. The definition of “confidential information” should explicitly encompass these derivative materials, often referred to as “derived information.”

Due to the relatively low demands placed on the buyer by the agreement and the burden of proof resting with the seller, negotiations over confidentiality and non-disclosure agreements are infrequent in practice. This contrasts with documents like letters of intent and definitive agreements, which are heavily negotiated.

Examples:

1. “Evaluation Material includes, without limitation, the Transaction and the Seller’s intellectual property, products, services, technical and business information and contact lists, together with all analyses, compilations, summaries, notes and data [derived information] and information conveyed in any form whether oral, visual, written, or electronic, and whether provided to Buyer before or after the date of this agreement.”
2. “Any information concerning Seller, regardless of form, manner or nature of information, which is provided to Buyer, and any notes, summaries, compilations, analyses or other documents prepared by Buyer to the extent that they contain or are based on, in whole or part, information provided to Buyer.”
3. “All of the Disclosing Party’s (i.e., Seller) business plans, present or future, or potential customers (including the names, addresses, needs and/or any other information concerning any customer or consumer), marketing, marketing strategies, pricing and financial information, research, training, know-how, operations, processes, products, inventions, business practices, databases and information contained therein, its wage rates, margins, mark-ups, finances, banking, books, records, contracts, agreements, principals, vendors, suppliers, contractors, employees, applicants, skill sets of applicants, sales methods, marketing methods, costs, prices, price structures, methods for calculating and/or determining prices, contractual relationships, business relationships, compensation paid to employees and/or contractors, and/or other terms of employment, employee evaluations, and/or employee skill sets.”

Common Issues in Defining Confidential Information

• Derived Information: “Derived Information” is sometimes addressed separately with its own set of restrictions. In practice, buyers’ analyses of the business can become intricately linked with their proprietary models, and they may want to safeguard their rights to formulas, methods, forecasts, or other intellectual property from the seller’s reach. Often, a middle ground is reached by explicitly defining confidential information to encompass the seller’s proprietary data.
• Labeling: Some agreements include a “labeling” or “legending” requirement, necessitating that the seller mark any information deemed confidential. However, in the age of electronic exchanges and predominantly oral information sharing (e.g., management discussions or customer interviews), this becomes an impractical administrative burden. Sellers should strongly oppose any excessive legending requirements, as they can slow down the process, and time is a critical factor when selling a business.
• Oral Information: In M&A transactions, a significant portion of the shared information is conveyed orally, often through interviews with managers or negotiations with key stakeholders. Therefore, any definition of “confidential information” should explicitly encompass orally conveyed data.
• Obligation to Provide Information: The agreement should not impose an obligation on the seller to provide information. While sophisticated buyers may request language obligating the seller to furnish information offered to other buyers, this could be unreasonable, especially when it involves sharing sensitive data with direct competitors. Contracts typically carry an implied duty of good faith, which can be argued to negate the need for an explicit obligation for the seller to provide information. Additionally, different sets of information are usually shared with different buyer groups, making it essential for the seller to retain flexibility in determining what, when, and to whom information should be disclosed.

Example: “Seller is under no obligation to furnish Buyer with confidential information, and Seller reserves the sole discretion to determine the nature and extent of information provided to Buyer.”

• Time Frame: The buyer may seek to exclude information obtained before the NDA’s execution or data unrelated to the potential acquisition, like teaser profiles or pre-NDA financial details. A well-crafted NDA should cover the period preceding its execution. Nevertheless, exclusions outlined in the “Exclusions” section (discussed in the following section) would still apply, including information that is “publicly known or available.”

Exclusions from Definition of Confidential Information

Exclusions from Confidentiality: Following the “Definition of Confidential Information,” it’s customary to find a section that specifically outlines exclusions to this definition. The seller’s preference is to maintain a broad scope while transparently listing these exclusions.

The recipient’s (i.e., buyer) objective, conversely, is to secure comprehensive exceptions to the definition of confidential information. Typical exclusions from this definition encompass:

• Information publicly known or already in the public domain prior to the time of disclosure.
• Information that becomes publicly known and widely accessible after disclosure through actions unrelated to the recipient.
• Information already in the recipient’s possession, without any accompanying confidentiality restrictions.
• Information acquired by the recipient from a third party without any breach of confidentiality.
• Information independently developed by the recipient.

Disclosure Period: Sometimes, information not disclosed during a specific disclosure period is also excluded from the confidential information definition. To ensure the protection of all information, regardless of when it was disclosed, it’s prudent for the seller to incorporate language covering information disclosed before the agreement’s execution.

Sample Language and Clarifications

1. “Information already in the buyer’s possession, provided the information is not subject to another confidentiality agreement.”

• Clarification: The buyer may consider adding a “knowledge qualifier” here, such as “to the best of the buyer’s knowledge,” to safeguard against potential undisclosed confidentiality agreements. Alternatively, a more stringent definition could require proof through “documentary evidence.

2. “Information available or generally known to the public, [other than as a result of disclosure of Buyer] [other than through the fault of the Buyer] [other than through a breach of this Agreement].”*

• Clarification: Removing “generally” from this statement eases the seller’s burden of proof. “Information known to the public” might also encompass data the buyer acquires from a third party on a non-confidential basis.

3. “Information Buyer develops without the aid of the confidential information,” or “Information that is independently developed by Buyer without the use of Confidential Information.”*

• Clarification: Most sellers might find this clause contentious since it places the burden of proof on them. Demonstrating that the buyer’s summaries or analyses were derived independently can be challenging for the seller, especially if the buyer restructures the information differently. Furthermore, once the buyer comprehends the data, they could potentially reframe it intentionally to exclude it from the “Confidential Information” category, allowing competitive use.

“Residual Information Clause: Clarification”

“Buyer is permitted to utilize the residuals resulting from any Confidential Information provided herein for any purpose. ‘Residuals’ refer to intangible information retained in the absence of access to Confidential Information, encompassing concepts, ideas, know-how, or techniques within their unaided memories.”

Comments:

The “residuals” clause acknowledges that confidential information can also reside in the buyer’s memory, not solely in written form. It recognizes the practical difficulty of expecting a buyer to completely erase or forget acquired knowledge when making strategic decisions. Under this clause, a buyer can employ the general knowledge they retain in their unaided memory without breaching the NDA. However, it’s important to note that specific, tangible information (e.g., software code) is still subject to confidentiality.

It’s worth considering the scope of this clause when dealing with direct competitors and sharing highly sensitive information. Collaborating with legal counsel to tailor the language for such cases, like excluding intellectual property rights or stipulating that no license is granted to the buyer for such data, may be prudent. Additionally, employing strategies such as restricting access to sensitive data or sharing it only at later transaction stages can further safeguard your interests. In situations involving direct competitors, thorough preparation for the sale is essential to ensure a smooth and secure transaction process, minimizing potential risks. It’s important to acknowledge that sharing sensitive information is sometimes unavoidable when selling to a competitor but can be managed with careful planning and legal guidance.

Permitted Uses

“Restrictions on Use: A Closer Look”

Also referred to as “Restrictions on Use,” this section defines how the buyer may utilize the disclosed information and typically confines its use exclusively to the evaluation of the transaction.

“Confidential Information shall be employed solely for the purpose of assessing a potential acquisition and shall not serve any other purpose, including actions deemed detrimental to the Seller.”

Comments:

Occasionally, objections arise from buyers regarding the phrase “in any way detrimental to Seller,” as they may argue that such language could be broadly interpreted to prohibit them from employing the information for competitive purposes that would be considered detrimental to the Seller.

Financial buyers, particularly those with portfolio companies operating in the same industry as the seller, may find this language overly restrictive. Separating their industry knowledge from the acquired information becomes challenging, especially when they evaluate numerous transactions annually. Managing a multitude of non-disclosure agreements across various portfolio companies and industries may become administratively burdensome.

In practice, the risk associated with disclosing information to financial buyers, such as private equity groups (PEGs), is often lower compared to disclosing it to competitors, unless the recipient is an executive within a PEG’s portfolio company. Executives at PEGs typically have limited involvement in their portfolio companies’ day-to-day operations and are primarily located at the corporate office.

Consequently, investment bankers often prioritize their buyer list based on risk assessment, initiating contact with financial buyers early in the process due to the reduced risk. Direct competitors may only be approached if they are likely to offer a premium price. These competitors are typically engaged later in the process, after refining the positioning and messaging based on feedback from the initial round of buyers. Initial discussions with buyers serve to identify and address any shortcomings in the offering memorandum, enhancing its strength as the sales process progresses.

Definition of Representatives

“Understanding the Scope of ‘Representatives’ in Confidentiality Agreements”

Confidentiality agreements serve to restrict the buyer from divulging confidential information to external parties. However, a commonly granted exception allows the buyer to share this information with their “Representatives” for the purpose of evaluating the transaction.

In most non-disclosure agreements, the “Definition of Representatives” typically encompasses the buyer’s employees, officers, advisors, and affiliates. While buyers generally favor a broader definition, it’s crucial to recognize that such inclusivity may expose them to increased liability for any breaches committed by these “Representatives.”

Before signing, thorough scrutiny of this section is essential. For instance, the language might encompass “financing sources.” However, without a precise definition of “financing sources,” this could potentially encompass any party providing any form of financing—be it debt or equity, regardless of the amount. With inventive interpretation, this could be exploited to significantly expand the NDA’s scope to include third parties without explicit consent.

“Representatives shall encompass directors, officers, employees, agents, affiliates, [potential] financing sources, or third-party advisors.”

At the very least, any involvement of third parties should obligate them to adhere to the NDA’s terms, with the buyer retaining liability for any third-party breaches. Furthermore, the buyer bears the responsibility of ensuring their representatives’ compliance with the agreement’s terms.

“Enforcing Confidentiality Through Buyer’s Representatives”

Alternatively, the seller can opt for the buyer’s representatives to sign a distinct NDA. This approach provides the seller with a direct legal recourse against third parties, allowing them to take legal action against the third party in addition to pursuing action against the buyer. Alternatively, the seller can include the representative as a signatory on the NDA through a joinder agreement, achieving the same objective.

Without a separate NDA involving third parties or the buyer’s liability for third-party actions, the NDA lacks the means to address breaches committed by third parties effectively. Essentially, the seller would be unable to directly enforce the NDA’s terms against third parties, and the buyer would bear no responsibility for the actions of these third parties, leaving no party accountable.

Hence, it is reasonable for the buyer to assume responsibility for the actions of their “Representatives” when separate NDAs or joinders with these “Representatives” are not in place. Additionally, the buyer should commit to promptly notifying the seller in case of any breach of confidentiality by their “Representatives,” as outlined in the following clause:

“Buyer agrees to promptly inform Seller in the event of a breach of confidentiality by itself or its representatives and will assist Seller in remedying the breach.”

Many confidentiality agreements stipulate that a breach caused by a “Representative” of the buyer will be treated on par with a breach by the buyer. This establishes strict liability for the buyer concerning its representatives’ actions, thereby incentivizing the buyer to exercise a high degree of caution in safeguarding the seller’s confidential information.

In some instances, buyers may seek to avoid strict liability for their advisors’ actions. If the advisor plays a pivotal role in the sales process, it may be prudent to request the third-party advisor to sign a separate confidentiality agreement. This enables the seller to directly enforce the agreement on the representative. As mentioned earlier, attorneys and accountants inherently uphold confidentiality duties, and their professional obligations are often considered sufficient.

Confidentiality Regarding the Transaction