Seattle, WA—March 1997

I had to hold the phone away from my ear to avoid permanent damage to my hearing. Charles, my Seattle-based textile manufacturing client, was livid.

“Do you know that your (adjective deleted for decency purposes) analyst faxed us, without any kind of warning, a copy of the draft Executive Summary describing our business for sale . . . and my manufacturing vice-president got the chance to read it before I even knew it was here? Damn it, how many times did I tell you and how many times did you agree that nothing was to be faxed to our offices without calling me first so I could get to the fax machine?”

Charles had told us this many times, we had agreed, and Eric (the analyst) was well aware of the client’s reasonable request. I winced for Eric but, in the moment, my first thoughts were of salvaging this business relationship, which I did not want to lose. Needless to say, Eric was seeking employment elsewhere that very day, even as I hopped a flight to Seattle to offer as many mea culpas and apologies as the situation required, which was a lot. In the end, Charles forgave us and stuck with us, though it probably took him a while to forget the unnecessary unpleasantness. Within the year, we helped him sell his business for a fairly spectacular price.

Last I heard, Charles was spending his time cruising the waterways of the Pacific Northwest.

McLean, VA—October 2000

Kamran, one of our senior analysts, had been out to dinner the night before with his girlfriend and her father in a local, somewhat-renowned Italian restaurant. He looked chagrined this morning and I asked him what was troubling him.

“Boss, I think I really screwed up.”

“Okay, tell me about it.” Damn it, it was only Monday, and I did not need anything this early in the week to screw it up. That would come later anyway, I thought, but let me get through Monday. I have always hated Monday in exactly the same proportion that I loved Fridays. I guess most of us do.

Apparently Kamran had casually mentioned a telecom deal he was working on, ostensibly in the privacy of a family (or soon to be a family, perhaps) conversation. The only problem: Kamran’s girlfriend’s father was an in-house attorney for a fierce competitor of the client, a point our young analyst did not realize at the time. Perhaps the girlfriend’s father saw “son-in-law potential” in the young analyst, because he kept his counsel, both literally and figuratively, and no harm was done. Even so, Kamran, who subsequently became a junior investment banker, walked around for days on pins and needles. To his credit, he was honest enough to tell me about the incident and how much he had learned from it. Ever since that day, when speaking about deals or potential deals in public, he uses code names and he encourages his junior colleagues to do the same. In fact, our firm does this as standard operating procedure now.

Confidentiality in General

Confidentiality in market M&A transactions is a serious concern in four areas.

• First, with employees of the selling company

• Second, with customers and suppliers of the selling company

• Third, with competitors of the selling company and the public

• Fourth, in cases where a public company is involved on one side or the other of a deal, as possible insider information

Confidentiality may seem like a side bar issue to inexperienced readers but frankly I have had clients, and just as frequently nonclients, refuse to even have lunch with me in a public restaurant out of concern that if anyone sees them lunching with me (in at least my hometown I am fairly well known as an M&A guy) the observer will immediately assume my lunch partner is for sale. I am not sure whether I am flattered by this or not. I know it limits my public lunch companions for sure.

Employees and Confidentiality: Two Approaches

There are, broadly speaking, two approaches for dealing with employees in the face of a business sales process being undertaken. Although I recommend the Controlled Disclosure approach, I must admit that my clients over the years have fairly evenly divided their approaches to this issue between that and what I call the Surreptitious approach. I will explain what I mean.

The Surreptitious Approach

In this approach the Middle Market business owner may choose to tell as few people as possible of his plans to sell the company. Under such circumstances, very few individuals beyond the immediate owners of the business and their principal financial advisors are aware of the impending sale. The surreptitious approach has clear advantages: The fewer people who know about a prospective sale, the less likely it is that news of the sale will fall into the wrong hands, to the disadvantage of the seller.

Yet the surreptitious approach has drawbacks of its own. Veteran investment bankers will observe from punishing experience that the longer it takes to sell a business (and six to twelve months is a reasonably long time, all in all) the more likely it is that word will get out through rumor mills, the most destructive and demoralizing of all information channels, too often rife with half-truths and misinterpretations that, in a Middle Market investment banking corollary to Murphy’s Law, invariably cast the impending sale in the worst possible light at the most inconvenient time—especially to employees who are caught off guard.

Rumor mills too often explode without allowing the principals any chance to attempt damage control, if the principals are even aware of the information leakage in real time. Employees who learn from rumor mills information about the sale that their Middle Market business owner(s) declined to share with them for any reason are likely to become angry, distrustful, demoralized, and fearful for their futures. The consequences to a company about to be sold can obviously prove problematic.

The Controlled-Disclosure Approach

Alternatively, Middle Market business owners may choose to release relevant information in a highly-controlled manner. Principals choosing the controlled-disclosure approach tell their key management people what they are doing and why, in a way that can help alleviate many concerns while possibly allowing those key people to look forward to new and better career opportunities that might result in the wake of the imminent changes.

While more people are aware of the imminent sale when principals choose the controlled-disclosure approach, the principals themselves have had the opportunity to frame the situation accurately, or at least on their own terms, while demonstrating a level of trust and confidence in their key people. The controlled-disclosure approach may even encourage key people to help the principals advance the sale and eventually to put their best foot forward when it comes time to inform the rest of the employees and, perhaps, key customers of the sale. If rumors do get out, especially to other employees, the “in-the-know” group can help relieve stress by explaining the possibility of a sales transaction or a recapitalization as just another step in the life of a business.

If this approach is taken, it may be desirable to indicate that the client has engaged an investment banker to explore alternative means to tap the additional capital and/or opportunities required to expand the business, whether via an M&A sale, a partial recapitalization, or other methods such as new strategic alliances. A seller’s honest ability to take this approach reflects the fact that most Middle Market businesses grow in stages. Their resource requirements vary over time when it comes to finances and capital, management experience, distribution channels, etc. In this regard, key people are likely to understand that new ownership or new capital may be desirable, as it may provide cash infusions and/or other resources that will allow the company to grow and thrive. Larger organizations with greater resources are more likely to provide better opportunities for career advancement to key managers of the selling company who intend to stay with the business.

The Investment Banker and Confidentiality: Communications between Banker and Client; Preventing Premature Disclosure

Whether the seller chooses surreptitious or controlled-release approaches to information sharing, or some combination of the two, unintentional breaches of confidentiality are sometimes unavoidable. The seller and his investment banker can do several things to minimize the risks of such information breaches:

1. Create an exhaustive written list of all persons who have been advised of the impending transaction within the client’s firm and among his professional advisors and family members. The investment banker’s job is to ensure that such a list is maintained and consulted before any contact is made with any of the above groups by the banker or his staff.

2. Maintain a list of email addresses, fax numbers, snail-mail addresses, courier addresses, etc., that are permissible for client/investment banker communications, while establishing standard procedures under which those addresses might be used. For example, investment bankers and their associates should agree not to fax any documents, even to agreed-upon fax numbers, without first notifying the client to ensure that he is standing by the fax machine or otherwise has secured it so that no other parties might intercept the document being faxed.

3. Only the investment bank’s senior investment bankers and analysts should be allowed to contact representatives of the client’s staff that have been cleared by the client in advance.

4. Under no circumstances should any member of the investment banker’s staff ever divulge the name of an existing client, or even the existence of a current engagement involving a company in a particular industry because an astute listener might well put two and two together and guess the identity of the client. We use and strongly advise the use of code names for all clients.

The Executive Summary and Confidentiality

The seller and investment banker should review the anonymous Acquisition Profile or Executive Summary very carefully before finalizing it and releasing it to prospective buyers. Here, as elsewhere, achieving the proper balance is imperative. Should the anonymous Acquisition Profile disclose too little detail (by relying too heavily on obfuscation to preserve client confidentiality), it may well prove less than helpful. On the other hand, should it disclose too much information, it will risk unmasking the seller’s company before prospective buyers have executed nondisclosure confidentiality agreement(s). An anonymous Acquisition Profile might suggest that the seller’s company is “located on the East Coast” or, more specifically, “is located in Maryland.” There are tradeoffs to be realized in either approach. The client and the investment banker should decide together which approach is best suited to their circumstances. Furthermore, depending on the intended recipient, the Acquisition Profile may be crafted differently for different buyers in terms of disclosures.

Web Site Business-for-Sale Listings

Web site and/or broadcast email should be very cautiously approached when it comes to “publishing” or distributing even disguised descriptive materials. Generally speaking, this approach to selling Middle Market businesses is inappropriate anyway in most cases and is more of a business brokerage technique than one used by investment bankers. A good investment bank need not rely on such tools except in the very rarest of circumstances (e.g., as a last resort).

Nondisclosure Agreements

Nondisclosure and confidentiality agreement(s) are designed not only to prevent a reader from stealing the “secret sauce” of a seller’s business (including employees, customers etc.), but also to provide some degree of confidentiality, so that a seller’s business is not harmed by disclosure to outside parties when he reveals his company’s actual name and business details in the follow-up Confidential Information Memorandum (CIM).

But do nondisclosure agreements (NDAs) really work? The answer to this most important question, as with so many others that must be addressed while selling a Middle Market business in an M&A transaction, is: “Yes and no. It depends.” Yes, to a large degree, NDAs do work. That said, the longer it takes for a deal to be consummated (or for the deal to fall through after an extended period), the greater the likelihood a mistake will occur and confidential information will be released or improperly used. There is something about being an insider on a deal that causes people to slip up, mentioning something offhand, or even bragging about a transaction to someone who should not know anything about it. Loose lips sink ships . . . and Middle Market M&A transactions. Veteran investment bankers will admit to having seen it the whole gamut, ranging from deals that were tight as a drum, with nothing being disclosed until the deal had been done, to deals in which information leaked out all too quickly.

One consolation to sellers, who quite justifiably can become very paranoid about leaks: Even when information does slip out prematurely, it only rarely does much harm in my experience. Slips only rarely cause sellers the harm sellers themselves typically anticipate with great dread. That said, everything that can be done to avoid leaks or interference with the clients business should be done. The best bet: Combine a strong Confidentiality /Nondisclosure Agreement with a clear conversation with the prospective buyer/investor as to the potential for significant harm to the client should leaks or misuse occur. Confidentiality agreements constitute a shot across the bow of the prospective buyer/investor; they really should make him or her think twice before violating them. It is also a fact worth mentioning that unauthorized disclosure or use of information may well give rise to legal recourse by the seller against the discloser or misuser. The biggest problem with such recourse, naturally, is proving that the disclosures or misuse occurred in violation of the agreement in the first place; that would be a matter for the lawyers to address.

Will Buyers and Investors Sign Nondisclosure Agreements?

Will prospective buyers and/or investors sign NDAs? Yes, the vast majority of them will sign (frequently though after some negotiation over the details), but investors in early-stage technologies may sometimes decline to do so. For example, in the late 1990s, venture capitalists received thousands of deal solicitations a year. Many of these were fairly harebrained, but the unfortunate VCs could never know when they might come across another “killer app” that sort of looked like the one that they signed a confidentiality nondisclosure agreement on a year ago. Think about it: if the VCs had agreed to sign nondisclosure documents for every last one of those deal solicitations, they might in fact have been signing away their right to do a more legitimate deal with a similar but more realistic technology or business. And what would prevent the authors of hare-brained schemes from claiming that their proposals contained an important kernel of insight that the VCs in fact found in another deal entirely? The VCs did not want to risk being sued, and so many of them simply refused to sign nondisclosure agreements. This situation still holds today. Many VCs will not sign NDAs, whereas later stage (buyout or recapitalization) funds have no problem with signing one.

Clients who really wanted a VC to look at a deal routinely were forced to waive nondisclosure and/or confidentially agreement provision(s). But most VCs and private equity groups (PEGs) do not exist for the purpose of stealing someone else’s ideas; they are too busy for such shenanigans, too honest to consider doing so, or, last but not least, too fearful and reticent to risk extended litigation.

Confidentiality and nondisclosure agreements will, in any event, usually exclude information that is either already public, already known to the party, or came to the parties’ attention in some other fashion.

Information That Cannot Be Disclosed until the Last Minute ... Even with a Nondisclosure Agreement

Occasionally, circumstances arise in which the seller, with good reason, refuses to release the full details of the information the buyer requires to make a final decision until the seller is convinced beyond doubt that the deal will close. Such situations usually involve disclosures of key customer(s), employee(s), or similar information. As a rule, these situations should be fairly rare, occurring in less than one in five transactions.

These circumstances can be handled by supplying the buyer just enough information so that the buyer knows what he is getting, but not enough to do any damage should the deal fail to close. If an issue arises involving a government contractor’s contract information, for example, the name of the government agency client and the general tasks to be performed might be disclosed early, while specific contract information is withheld as long as possible, especially concerning actual contact with the customer. Titles, job functions, and educational levels of key employees could and usually are released (in the CIM), while names might be withheld until the last minute.

One way or the other, the buyer will need to know this very final information before the final settlement. The seller and investment banker might decide to delay final disclosures until definitive agreements have been fully negotiated and executed, and then allow the buyer, say, 24 hours to repudiate his agreement if he does not like what he sees in the seller’s final disclosures. Whether such disclosures are made just before or just after the definitive agreements are executed (or even in some cases after a dry settlement, in which no money changes hands or in which monies are escrowed) probably will not negatively affect final closure anyway. By the time settlement arrives, both parties tend to be emotionally and financially committed to the deal and have spent so much time and even more money on attorneys, accountants, and so forth that neither side is likely to indulge in any final game-playing. What would be the point?

Securities Laws and Confidentiality

When public companies are involved in Middle Market M&A transactions, special care must be taken to preclude premature and inappropriate disclosures of what might be insider information. A failure to do so can result in severe penalties for even a minor screw-up: criminal, civil, and regulatory penalties, as well as penalties to others outside the company who should have known better.

Chapter Highlights

• There are two basic approaches to disclosing to employees the impending sale of a business: the surreptitious approach and the controlled-release approach.

• The client and the investment banker should agree to strict rules regarding all transaction-related communications and should establish dedicated email and snail-mail addresses and an agreed-upon list of client management contacts as required.

• The anonymous Acquisition Profile must achieve a fine balance by adequately describing the business without prematurely disclosing its identity.

• Web site businesses’ for-sale listings generally are not advisable or useful and may in fact risk disclosing the imminent sale of the business to the wrong people.

• Nondisclosure agreements (NDAs) are basically warning shots across the bow of signing parties, alerting them to possible liability from improper disclosure or misuse of the information learned about the client.

• Some VC parties will decline to execute NDAs (for good reason).

• Occasionally, confidential information should not be disclosed until the last minute. Information that is absolutely sensitive can be disclosed subject to and following a dry settlement.

• Disclosure of deal information may constitute a violation of securities laws when a public company is a party to the deal.

EXHIBIT 8.1 Sample Confidentiality Agreement