M&A Guide | Selling Your Business to a Competitor

A competitor has recently reached out to me with an interest in purchasing my business. I’m eager to engage in a discussion, albeit with a confident stance. While I’m open to exploring this opportunity, I want to ensure that my sensitive information remains safeguarded. The question arises – are they genuinely interested or simply seeking information? Given the necessity of sharing confidential details, I’m cautious about accepting the offer outright.

To bolster my confidence, I’m keen on fortifying the non-disclosure agreement. What steps can I take to ensure that this agreement offers me the maximum protection possible? Additionally, I’m determined to uphold the security of my trade secrets and other proprietary information throughout this engagement with a competitor. Any insights on strategies to achieve this would be greatly appreciated.

Ensuring the utmost security and confidentiality of your business particulars remains of paramount importance, a stance even more resolute when faced with a competitor’s approach.

This insightful article delves into an array of potent strategies, empowering you to assert your protection while orchestrating the sale of your business:

• Graduated buyer engagement to manage escalating risk levels
• Meticulous buyer vetting procedures
• Controlled information dissemination over progressive phases
• Astute discernment of what and when to disclose
• Imprint documents with the seal of “confidential”
• Entrust a neutral third party to expertly oversee due diligence
• Tailor a bespoke non-disclosure agreement (NDA) suited to the buyer in question

Let us embark on this journey of knowledge and preparation!

Contact Buyers Based on Increasing Stages of Risk

Commence by engaging buyers who inherently pose the least risk to both you and your company. This often involves initiating communication with private equity firms and indirect competitors.

Interacting with these buyers inherently entails the most secure approach for your business. This approach stands as the established norm in the realm of private auctions, particularly when you’re supported by an astute M&A advisor.

The approach of prioritizing low-risk buyers for initial contact provides an invaluable opportunity to refine your presentation and strategic positioning before connecting with those of greater priority or potential risk. These initial interactions will inevitably unearth potential drawbacks, deal-breakers, or areas of vulnerability that might elude even the most meticulous preparation for your company’s sale.

By initially focusing on a cohort of buyers with minimal risk and priority, you expertly avert any risk of jeopardizing a favorable first impression with those of higher significance. This methodology consistently yields constructive feedback, instrumental for refining future buyer presentations and invariably enhancing the likelihood of a seamless transaction.

Illustrating this strategy, we recently facilitated the sale of a prominent commercial cleaning company. Our chosen approach involved initially reaching out to several out-of-state competitors, poised to benefit from expanding their geographical footprint. The rationale behind considering these entities low-risk stemmed from their non-involvement in our business’s immediate geographic arena. Similarly, in a different scenario, we successfully executed a comparable strategy to divest a substantial landscaping enterprise. In this instance, we engaged with indirect competitors within the same geographic locale. This avenue, while representing lower risk due to their status as prime acquisition prospects without direct competitive standing, was part of our strategy. We reserved direct competitor engagement as a final recourse. In both scenarios, our initiation with low-risk prospects enabled us to meticulously refine our approach until securing the perfect suitors for each business.

Thoroughly Screen Buyers

Thoroughly vet the potential buyer before divulging any information. Ensuring the buyer’s qualifications are up to par is paramount, and as due diligence advances, you can delve deeper into your inquiries.

We initiate the process by requesting interested parties, even competitors, to complete a comprehensive “Buyer Package.” This comprehensive questionnaire delves into numerous aspects, encompassing their financial standing and past acquisition ventures. This meticulous process serves as a prerequisite before we unveil any business-related details. If a buyer hesitates or declines to furnish this essential information, we withhold any further disclosure.

Should a buyer insist on conversing with your customers during the later stages of due diligence, you can tactfully counter by expressing your interest in conversing with their key personnel, prior business owners they’ve acquired, or other pertinent contacts.

In cases where the confidentiality of shared information holds high stakes, contemplate engaging a proficient private investigator. These adept professionals wield an array of resources, including databases, to swiftly uncover any potential red flags in an individual’s or company’s background.

Enlist the support of your legal counsel to scour public records, gauging any history of litigious involvements.

Considering the wisdom of appraising the buyer’s credit—either on a business or personal level—can prove prudent.

For those moments when reservations about the buyer’s financial capability arise, delving into comprehensive financial documentation to validate their transaction potential is a judicious move. Trust your instincts. If specific aspects raise doubts, don’t hesitate to conduct deeper investigations.

For instance, when confronted with questionable assertions about their prior acquisitions, requesting a conversation with an acquired company’s former owner is both reasonable and well within your rights, especially when the buyer seeks access to highly sensitive data.

Release Information in Phases

Reveal information to the buyer in a progressive manner that aligns with their sustained interest in your business. This strategic approach involves the gradual disclosure of increasingly sensitive details as mutual understanding and trust with the buyer are established.

To illustrate, safeguard highly confidential information, such as customer contracts, and unveil them only during the advanced stages of due diligence.

Initiate early conversations with potential buyers by sharing general information while judiciously holding back sensitive data – especially information that could be exploited by competitors. The unveiling of such sensitive details should be reserved for the later stages of the negotiation process or, alternatively, could be considered only if deemed necessary.

Introducing time-bound milestones for the buyer can prove effective. By segmenting the due diligence process into distinct phases, you can require the buyer’s endorsement upon the successful completion of each stage.

For instance, commence with financial due diligence, and once this step is satisfactorily executed, seek their confirmation before transitioning to the subsequent phase of due diligence.

While this staged approach might suit specific businesses, it might be less pragmatic for many acquisitions due to the iterative nature of due diligence. Alternatively, a more streamlined strategy involves deferring the dissemination of sensitive information until the latter stages of due diligence.

Know What to Release and When

Let’s outline the standard information shared with potential buyers.

Information regularly provided to buyers includes:

Financial & Tax

• Profit and loss statements
• Balance sheets
• Cash flow statements
• Bank statements
• Federal income tax returns
• Reports for payroll and sales tax
• Statements from merchant accounts
• Schedule of accounts receivable and payable

Legal

• Copy of the premises lease
• Supplier and vendor contract copies
• Advertising contracts
• Insurance policy copies
• Equipment lease copies
• Copies of significant contracts

Operations

• List of assets
• Inventory list
• Marketing materials
• Copies of licenses, permits, certificates, registrations, etc.

Information occasionally shared with buyers:

• Pricing details concerning specific customers or clients
• Customer contracts (with names typically redacted)
• Employee information, agreements, and related data
• List of suppliers

Information typically not disclosed to buyers:

• Software code
• Customer names (both current and prospective)
• Trade secrets

Mark or Stamp Documents ‘Confidential’

Assert your commitment to confidentiality by imprinting every document with the label “Confidential” before sharing them with the buyer. While this step might not be obligatory within the realm of most NDAs, it stands as a formidable practice that unambiguously conveys the sensitive nature of the information you entrust to their hands.

Appoint a Neutral Third Party to Facilitate Due Diligence

Enlist an impartial third party to carry out due diligence on behalf of the buyer. This neutral entity’s sole responsibility will be conducting due diligence, with no involvement in passing along confidential information to the buyer.

Consider this scenario: if you’re the owner of a software company, both you and the buyer could collaborate to hire an unbiased third party to conduct a thorough code audit. This third party would exclusively access your software code. Once the code audit is complete, they would compile a comprehensive report to be presented to the buyer for in-depth analysis. This approach ensures limited exposure of your confidential software code.

Alternatively, in situations where your business heavily relies on a handful of key clients who contribute a substantial 70% of your revenue, a third party could be employed to conduct customer surveys, guaranteeing the satisfaction of these crucial clients. In certain cases, the transaction itself can be structured to obscure the fact that the company has been acquired – a tactic we recently employed when selling a significant service firm in Chicago.

When sensitive financial details need to be disclosed to the buyer, it’s prudent to jointly engage an independent CPA firm to conduct financial due diligence.

While inherent risks exist when sharing sensitive business information during the sales process, adopting these strategic measures can effectively mitigate those risks while still enabling the conveyance of necessary business information to potential buyers.

Prepare a Custom or Buyer-Specific NDA

Goals of an NDA

Objective #1: Manage Conduct

The foremost aim of the NDA is to preempt breaches of confidentiality. When the terms are transparent, achieving this objective becomes more feasible. Considering this, in smaller transactions, it proves advantageous to emphasize the confidential nature of the venture during the initial conversations or meetings with the buyer.

It’s worth noting that an excessively intricate NDA might inadvertently yield counterproductive results. Regrettably, some buyers skim through the NDA’s terms, wrongly assuming them to be boilerplate. In such instances, reiterating the NDA’s significance can be valuable, especially if the buyer lacks significant acquisition experience.

Should the buyer engage in negotiations over the NDA’s language, it can signal a positive inclination. This suggests a vigilant commitment to honoring agreements. In pursuit of behavior control, the NDA’s language should unequivocally embody clarity, conciseness, and an absence of legal jargon.

Objective #2: Establish a Legal Recourse

In scenarios of NDA violations, litigation commonly emerges as the primary recourse. However, the meticulous wording holds limited relevance if the buyer doesn’t grasp the subtleties of the NDA’s language. Nevertheless, our belief centers on the NDA primarily serving the goal of behavior management and prevention. When the initial objective of “behavior control” is effectively achieved, the necessity for litigation diminishes. In striving for behavior control, the NDA’s language should be readily comprehensible and crystal clear.

Having elucidated the NDA’s purpose, let’s proceed by offering valuable strategies to bolster the NDA’s potency when dealing with direct competitors.

Prepare a Buyer-Specific NDA

Secure your position by entrusting your attorney to craft a tailored NDA exclusively designed for the buyer with whom you’re in negotiations. While a generic NDA serves well in the initial phases, confronting a direct competitor while divulging intensely sensitive data necessitates a uniquely tailored NDA, meticulously crafted by your legal counsel. Rest assured, this tailored approach will reinforce your strategic advantage and safeguard your confidential information.

Prepare a Separate NDA for Different Categories of Information

Diversified NDAs can be meticulously tailored to distinct categories of confidential information, each encompassing the requisite language pertinent to specific scenarios.

To illustrate, consider these diverse scenarios, each demanding a unique array of legal strategies and language to fortify your protection: when the buyer engages with essential employees, when interactions transpire with pivotal customers, and when proprietary pricing details are shared with the buyer. Through this strategic approach, your confidentiality measures gain precision and efficacy across varying contexts.

Customize the NDA

Adapting an NDA often becomes necessary for specific buyer profiles.

For instance, we employ distinct approaches for affluent private individuals, direct competitors, and private equity groups. Our procedures are notably stringent with competitors, given the heightened risk these transactions pose to sellers. The safeguarding efficacy of a non-disclosure agreement hinges on the nuances of its language. In the middle-market segment, negotiation of the NDA is commonplace, particularly when potential competitors are involved.

Areas within an NDA that warrant distinct treatment when dealing with competitors encompass:

• Inclusion of orally communicated information
• Incorporation of “derived information”
• Classification of the business’s sale status as confidential information
• Definition of “representatives”
• Definition of “confidential information”

Consider incorporating the subsequent language into the NDA for competitor engagement:

• Non-Solicitation: Integrate a clause wherein the buyer commits to refraining from actively soliciting your customers, suppliers, or employees. See the accompanying tips for optimal introduction of this clause.
• No-Hire: The buyer pledges against employing your staff, as opposed to merely avoiding solicitation.

Ask the Buyer’s Representatives to Sign an NDA

Prioritize obtaining a signed NDA from the buyer’s representatives before sharing your information. In cases where the representatives don’t comply with signing the NDA, it’s essential to hold the buyer responsible for any breaches committed by their representatives.

Furthermore, ensure the buyer provides the names and contact details of their representatives upon receiving information about your business. This straightforward approach strengthens information security and accountability.

Have the Buyer Sign Multiple NDAs

Utilize a strategic approach by requesting the buyer’s execution of distinct NDAs at different stages of the transaction’s progression. Each subsequent NDA can encompass progressively more stringent language and clauses as you progressively disclose more sensitive information.

For instance, a buyer might initially show little interest in signing an NDA containing non-solicitation or no-hire clauses. However, as negotiations advance, they might be more inclined to accept such terms, especially if they’re granted the opportunity to engage with your employees during due diligence.

In certain cases, your attorney may need to draft an NDA before granting the buyer access to key customers. While relatively uncommon, this step might be necessary in transactions involving concentrated customer relationships. Should such situations arise, negotiation of the NDA could be a prerequisite before permitting discussions with these critical customers.

Clauses to Consider Modifying

Having provided several practical tips, let’s delve into the specifics of the NDA’s language.

Definition of Confidential Information: This is an often-negotiated segment. Many agreements offer a broad definition of confidential information while outlining specific exceptions. Pay particular attention to addressing any information that raises particular concern.

Example:

“Confidential Information” pertains to data about the Company, its Customers, Customer Prospects, and/or Vendors that remains undisclosed outside the Company’s purview. This pertains to information acquired in connection with your role at the Company. The scope of Confidential Information may encompass, but is not limited to: (1) Agreement terms, excluding disclosures to your subsequent employer’s awareness of restrictive covenants, your attorney, spouse, or tax advisor – with the understanding that disclosure by any such party shall be considered a violation; (2) Company policies, finances, and business strategies; (3) Financial projections, encompassing sales forecasts, market share computations, and targets; (4) Sales insights pertaining to product launches; (5) Customized software, marketing tools, and resources accessed or generated through Company affiliation; (6) Identification of Customers, Customer Prospects, and/or Vendors, including contact details; (7) Lists of Customers, Customer Prospects, and/or Vendors; (8) Account terms and vendor pricing details; (9) Account terms and pricing within sales contracts; (10) Anticipated terms and pricing in sales contracts with Customer Prospects; (11) Employee and business contact information; and (12) Strategies, methods, and approaches for product development, manufacturing, marketing, distribution, and sales.

Clarification of Representatives: Many NDAs grant buyers the authority to share sensitive information with their “representatives” without explicit consent from you. However, some agreements overlook defining the scope of a representative, a practice we do not endorse.

Our recommended approach entails an NDA that mandates the buyer to obtain your consent before disclosing confidential information to third parties. Simultaneously, the agreement should provide a comprehensive definition of what constitutes a representative.

Example:

As stipulated within this agreement, the term “Representatives” pertains to your affiliates, and both your affiliates’ respective directors, officers, employees, agents, and advisors. This encompasses financial advisors, attorneys, accountants, and other consultants associated with you and your affiliates, subject to the condition that said advisors shall not concurrently be, or eventually evolve into, co-bidders or sources of equity or debt financing.

Permissible Usage: The NDA should distinctly state that confidential information’s utilization is exclusively permissible for the evaluation of the transaction, eschewing any alternative purposes.

Example:

The Receiving Party expressly commits that the Evaluation Material shall exclusively serve the purpose of assessing a potential Transaction, refraining from any other utilization that could adversely impact the Disclosing Party. The Receiving Party and its Representatives are barred from disclosing this information to any other individual or for any other purpose. However, such information may be shared with the Receiving Party’s Representatives requiring it for Transaction assessment, provided they pledge to maintain confidentiality and adhere to this agreement’s terms as if they were signatories. The Receiving Party bears responsibility for any breach by its Representatives, committing to take all reasonable actions at its expense to prevent unauthorized disclosure or use of the Evaluation Material.

Legal Obligations: Most NDAs stipulate that buyers can divulge confidential information when legally compelled to do so. Rigorous NDAs, advocating for the seller, grant the seller avenues to intervene before such disclosures and provide protective measures.

Example:

In the event that the Receiving Party or any of its Representatives is legally obligated to disclose any portion of the information in the Evaluation Material due to a valid and enforceable subpoena or order from a court, governmental body, or stock exchange, the Receiving Party commits to promptly inform the Disclosing Party about the request, including its context and terms. This allows the Disclosing Party to seek appropriate protective orders or waive the Receiving Party’s adherence to this agreement (and if the Disclosing Party seeks such orders, the Receiving Party will cooperate at the Disclosing Party’s expense). If protective measures are denied and the Receiving Party must still disclose the information, it or its Representatives will only reveal the portion mandated by the written opinion of the Receiving Party’s legal counsel, making every effort to safeguard the remaining confidential material. The Receiving Party and its Representatives won’t oppose any action by the Disclosing Party to acquire protective orders or prevent disclosure, ensuring continued confidentiality.

Return or Disposal of Information: The NDA mandates buyers to return or dispose of information if they opt out of the transaction, although the relevance of this clause can vary due to technological advancements.

Access to Employees: This remains a contentious matter. All NDAs should initially limit employee access. If granting employee access, we strongly advise having your attorney draft a non-disclosure clause addressing employee non-solicitation before permitting buyer-employee interactions.

Example:

You and your Representatives shall not initiate or facilitate any communication concerning the Evaluation Material, meetings with management related to a potential Transaction, or discussions regarding the Company’s business or a potential Transaction without prior written consent from the Company [or the Company’s investment bank]. These actions shall not be taken, except through a financial advisor designated by the Company, with any officer, director, or employee of the Company or its affiliates.

Non-Solicitation of Customers, Employees, Suppliers: This section often sparks intense discussions, and some buyers might resist signing an NDA containing such language during initial transaction stages.

To ease this, you can specify that the buyer commits not to actively pursue your employees, but your employees can be considered if they apply through general employment advertisements.

Example:

Within a three-year span from the present date, the Receiving Party and its affiliates agree that they will refrain from directly or indirectly hiring or soliciting any current employee of the Company without obtaining the Company’s prior written consent. However, this provision does not apply to general employee searches conducted through media advertisements not specifically aimed at Seller’s employees.

No Obligation to Proceed: The NDA should unambiguously state that both parties have no binding obligation to proceed and that the aim is not to create a legally binding commitment.

Disclaimer Regarding Accuracy: To safeguard the seller, the NDA should explicitly state that the seller doesn’t provide any warranties concerning the accuracy of the shared information.

Example:

The Receiving Party acknowledges that neither the Disclosing Party nor any of its Representatives offers any explicit or implied representation or warranty about the accuracy or completeness of the Evaluation Material. The Receiving Party agrees that, aside from any breaches of this Agreement, neither the Disclosing Party nor its Representatives will bear any liability towards the Receiving Party, its Representatives, or shareholders (or other equity holders) on any grounds (including, but not limited to, contract, tort, federal or state securities laws, or other) and the Receiving Party and its Representatives will not make any claims against these entities. This covers potential aspects such as a potential Transaction, this Agreement, or any other written or verbal communication concerning a potential Transaction; the Receiving Party’s engagement and that of its Representatives in assessing a potential Transaction; the scrutiny or use of the Evaluation Material’s content, any errors, or omissions; or any actions taken or not taken based on the Evaluation Material. Exceptions apply only to those matters included in any definitive agreement concerning a Transaction.

Term: All NDAs should specify a term, typically ranging from two to three years. Opt for the longest term feasible.

Choice of Law: It is advisable to select your home state for this clause.

Injunctive Relief: The NDA should explicitly empower the seller to seek an injunction if immediate damage is imminent.

Assignment: Make it clear in the NDA that most of them are non-assignable.

Conclusion

In the context of engaging with a competitor, we recommend the following steps:

• Reach out to potential buyers in a progressive risk-based manner.
• Seek legal assistance to craft a customized NDA tailored to each buyer.
• Conduct a thorough assessment of the buyer’s background.
• Share information with the competitor gradually, in stages.
• Apply a “confidential” stamp to all relevant documents.
• Consider involving an impartial third party to facilitate due diligence.
• Enlist your attorney to draft a specialized non-disclosure agreement for the competitor.
• Ensure that the buyer’s representatives also commit to a non-disclosure agreement.
• Request the buyer’s signature on additional non-disclosure agreements as the transaction advances.