Chapter 7

Assuring Confidentiality

In This Chapter

Enticing Buyer interest with a teaser

Securing a confidentiality agreement

Avoiding confidentiality breaches (and taking care of any that occur)

Elmer Fudd had the right idea; the wabbits surely would’ve scattered if he’d announced his intention to shoot up the forest. Similarly, broadcasting the details of an ongoing M&A deal can have disastrous effects (especially if you’re the Seller). That’s why confidentiality is so important in mergers and acquisitions. In this chapter, I introduce you to the methods Buyers and Sellers utilize to assure confidentiality.

Tempting Buyers with an Anonymous Teaser

A teaser is an aptly named document: Its intent is to give a Buyer just enough information (the product, the customers, the problem the company solves, and some high-level financials) to make him want to learn more. Another aspect of the teaser is that it’s (usually) anonymous. Most often, a Seller’s M&A advisor (investment banker or business broker, usually) is the person who forwards the teaser to a Buyer.

I don’t recommend sending teasers to Buyers without initially phoning them to have a conversation to gauge whether they have any interest in the opportunity. This method keeps me from wasting my time and theirs. Also, speaking with Buyers means they’ll be expecting your teaser and will most likely give it proper consideration instead of considering it unsolicited junk mail. Of course, I sometimes make an exception if I have a long-standing business relationship with a particular Buyer who knows me well and will take a look at my e-mail because I’ve already established my credentials as a professional, serious business person. (Those who know me, stop rolling your eyes!)

If, after reviewing the teaser, the Buyer isn’t interested in learning more about the company, the advisor hasn’t disclosed the fact that a specific company is for sale. No names are divulged until the Buyer signs a confidentiality agreement (CA).

Teasers are obviously not anonymous if an employee of the selling company contacts Buyer. Using an intermediary (see Chapter 5) is imperative if Seller wants to maintain anonymity until a confidentiality agreement is in place. I cover confidentiality agreements later in this chapter.

Anonymity is another important facet of the teaser. If a competitor learns that a company is for sale, it may use that information to spook the common prospects and even steal existing clients of the selling company. Also, all things being equal, if you don’t need to give up a bit of information, why should you?

Another important reason for the teaser is that a slow release of information is often better than dumping everything in Buyer’s lap all at once. If Buyer is inundated with information, he may not be willing to dig in and find the reasons why he should pursue a deal. It’s analysis paralysis. Releasing information slowly makes moving to the next step easy for Buyers.

Keeping it short and sweet

Brevity is the soul of a well-written teaser, so keep it to one page. The reader needs to quickly understand what the company does. The teaser doesn’t need to delve into details; that’s what the offering document is for (see Chapter 8). The teaser just needs to impart the basics.

Sellers, get to the point! The teaser should only provide enough information to spark the Buyer’s interest. Don’t waste time reconstructing the development of your industry or trying to impress the reader with your encyclopedic knowledge of this or that. Get to the salient points. Write it so that your mother can understand it.

Buyer isn’t a “black box” that automatically and immediately processes a huge amount of data. Buyer is a person or a group of people who need time to process that data. Providing an overload of data will most likely result in Buyer not even bothering to wade through it; he has tasks he can do that require less effort!

Including high-level financial info only

In the spirit of brevity (see the preceding section), the only financials a teaser needs are revenue and EBITDA. (If a company has an excess of add backs — see Chapter 8 — the teaser should use adjusted EBITDA.) Some industries or situations may require slightly more financial information, such as gross profit of EBIT or other specific statistics (number of customers, units sold, and so on).

A teaser should have three to five years of historical financial recap plus three to five years of projections. For ease of use, the teaser’s income statement should also show expenses as a percent of revenue.

Sellers, don’t go overboard. Err on the side of keeping it simple. If the statistic doesn’t add anything, don’t put it in the teaser. Remember, Buyer may or may not be an expert in your specific industry, so give him only what he needs.

Touting key selling points

These selling points are the key strengths of the business. Companies have certain key discrete value propositions that differ from company to company and from industry to industry. Here are some examples:

Proprietary relationships with vendors: If a company is the only company (or one of a limited few) that can buy from a certain vendor, that’s a selling point you can trumpet in the teaser.

Nature of customer relationships: For some Buyers, acquiring companies with Fortune 500 relationships is a main consideration. For others, selling to consumers or middle market companies is the key aspect.

Average sale size: Some Buyers want to acquire companies that make large sales. The larger the average sale size, the faster/more easily the company can grow.

Recurring revenue: Similar to average sale size, the holy grail of recurring revenue (revenue that occurs over and over again after making the initial sale; think of your cellphone bill) helps a company grow. A company doesn’t need to have 100 percent recurring revenue; the more the better, of course, but any amount of recurring revenue is worth mentioning in the teaser.

Revenue growth: A company with growing top-line revenue usually has growing bottom-line profits.

Profitability: The only thing better than a highly profitable company is a highly profitable company that’s growing.

Proprietary whatever: If the company has proprietary software or processes — something that the competitors don’t have — that becomes a potential selling point.

The items in the list are just some examples. The teaser should highlight whatever makes the company special and different. You can find an example teaser in this book’s appendix.

Executing a Confidentiality Agreement

If a Buyer is interested in seeing more after reading the teaser (covered in the preceding section), the Seller should execute a confidentiality agreement with the Buyer.

A confidentiality agreement, or CA (also known as a non-disclosure agreement or NDA), is an arrangement where both parties agree to share information with each other but to refrain from sharing the information with outsiders.

They also promise not to divulge the fact that discussions are ongoing. In other words, if you sign a CA, you agree that you can’t even talk about the talks!

The CA isn’t just a piece of paper or some perfunctory step in the M&A process. It’s a serious legal document, and you need to treat it as such. Signing a CA means you have a legal and ethical obligation to keep your mouth shut.

Perusing the CA’s contents

Here are the key aspects of a confidentiality agreement:

Confidentiality: This one seems like a given, but it’s nice to get this agreement down on paper.

Make sure the agreement excepts information already known, such as public information or general information, from the confidentiality requirement.

Use of materials: The CA specifies that any materials exchanged during the M&A process are for evaluation purposes only. In other words, don’t use the evaluation materials to, say, write your own business plan or create a TV sitcom.

Disclosure of materials: Despite a pledge of confidentiality, the CA also explicitly states who the parties are allowed to disclose information to, such as outside advisors. Each party agrees to be responsible for any breach that its advisors cause.

Who’s covered: A CA specifies the identity of Buyer and usually includes language stating that Buyer can inform employees and advisors (lawyers, accountants, investment bankers, and so on) of the transaction and share information with these advisors. Buyer agrees to inform these other employees or advisors about the CA and be held responsible for any breach of confidentiality by these employees and advisors. Check out the later “Keeping the Cat in the Bag: Advice for Buyers” section for more.

Destruction of materials: The recipient of confidential material agrees, upon request, to either return the materials to the source or destroy them.

Chain of command: The CA defines the chain of command all deal-related correspondence should go through.

Period of enforcement: A good CA specifies the length of time the agreement is in force, usually one to two years. Don’t sign an agreement that lacks an end date; you don’t want your hands to be tied indefinitely.

Most confidentiality agreements are boilerplate legalese and don’t differ that much from document to document. But you should read any CA before signing it to be on the lookout for language that differs from the norm. If something is out of sorts with the CA being offered, discuss it with the other side. As with everything in the M&A process, you don’t have to accept a CA as is.

Figuring out which party sends the CA

Who sends the confidentiality agreement depends upon who initiated the contact. If a Seller is contacting a Buyer, she usually attaches the CA to the teaser, often with instructions (or polite reminders) for the Buyer to sign the CA if he wants to see the full book (or offering document, which I discuss in Chapter 8).

A Buyer contacting a Seller should have a CA at the ready. However, Buyer may want to offer Seller the option of using either her own CA (if she has one) or Buyer’s CA, whichever makes Seller the most comfortable.

Determining who gets more value out of the CA

The confidentiality agreement is most helpful to Seller because she’s giving up the most confidential information and is more at risk from others finding out that M&A discussions are ongoing. (Flip to the earlier section “Tempting Buyers with an Anonymous Teaser” for more on why these revelations are risky for Sellers.) The CA is so valuable to the Seller that any Seller contacted by a Buyer should execute a CA with the Buyer before any meaningful conversations occur.

On the other hand, the fact that Buyer is interested in making acquisitions has no negative impact on him. Seeking acquisitions essentially says that a company is so successful and profitable that it can afford to buy other companies. That’s hardly a disclosure that can provide a competitor with an advantage.

Handling a Breach of Confidentiality

Breaching the confidentiality agreement means one party has not followed the conditions of the agreement, therefore violating the agreement. Breaches are serious occurrences and should be dealt with head on and immediately.

Here are some common types of breaches:

Speaking out of school: Somebody privy to confidential information starts flapping his gums to his golf buddies or at Friday night cocktails or a lunch meeting.

Buyer making improper contact with Seller’s employees: Buyer contacts one of Seller’s employees, specifically someone who isn’t involved in the potential deal, without Seller’s permission, alerting that employee that the company is for sale.

Involving a loose-cannon advisor: An advisor who knows of the impending deal (usually someone who’ll be brought in only if the deal moves forward) can’t resist making comments to friends and strangers alike.

One of the signers of the confidentiality agreement may cause a breach, but in my experience that situation is very rare. The person signing the document is usually acutely aware he just signed a document! More than likely, the weak link occurs elsewhere in the chain.

The two most common weak points — the people most apt to cause a breach of confidentiality — are advisors and executives or other employees, both of whom can be further broken down into “active” and “I hope I get hired” categories. In fact, those employees or advisors who hope to get hired or retained if the deal closes often cause the most problems.

Confirming a breach

Although some breaches are easy to confirm (people who shouldn’t know about the deal talk to you about it), others are more difficult to nail down if you don’t receive direct knowledge of it. If you suspect a breach, immediately pick up the phone and have a conversation with the other side. (If you’re a Seller represented by an intermediary, call him immediately and have him deal with the situation.)

A phone conversation is important because you can gauge the other side’s tone and reaction to the news. Writing a lengthy, accusatory e-mail (or leaving a length, accusatory voice mail) may end up muddying the waters more than clearing them. You need to hear the other side’s story.

Only send an e-mail to recap your conversation about the breach of confidentiality. If you’re unable to get the other side on the phone, leave a brief message and send a short e-mail. Simply say that you urgently need to speak with the other party as soon as possible; you have some concerns about confidentiality. Don’t go into detail in the message or e-mail.

I’ve dealt with the occasional breach during my deal-making years. In each and every example, I contacted the other side and had a conversation. In some cases, the other side apologized and immediately took steps to fix the problem. In other cases, where the breach wasn’t as clear, the phone call served to raise the other party’s awareness to a potential problem, and the breaches magically stopped.

Thinking long and hard about legal action

Although your first instinct may be to sue the pants off the offending cause of the breach, remember that lawsuits can be expensive, lengthy, and time consuming and may end up hurting you more than helping.

In every breach I’ve encountered, we were able to eventually complete a transaction without getting the courts involved. Starting a lawsuit would have greatly compromised our ability to close a deal.

Talk to your lawyer and your intermediary about a breach or suspected breach. Although you want to avoid legal recourse if possible, doing more than talking to the other side may be the best course of action. It’s a bullet you may have to bite.

In case of a dispute, the confidentiality agreement usually designates the state where the dispute is heard in court. The jurisdiction is often a sticking point, especially if Buyer and Seller are in different states. Each party may prefer to use its home state as the jurisdiction. In that case, a third state (most often Delaware, due to its standing as a business-friendly state) is usually the best option.

Keeping the Cat in the Bag: Advice for Buyers

As I note earlier in the chapter, a confidentiality agreement is a serious and real legal document, and a Buyer who signs a CA should take every precaution to speak only with those who need to know about the business and are covered by the CA. The following sections give you some guidelines on who you can talk to and how to discuss sensitive information without letting the whole county know.

Involving employees and advisors

Generally, a confidentiality agreement allows the signers to speak with employees and advisors about the transaction. The CA specifically delineates these people by job title or function (not by name).

In the CA, relevant employees are usually designated with a line such as

“Employees who have a legitimate need to know in order to evaluate a possible transaction are permitted to review materials.”

The language for advisors typically goes something like the following:

“Independent accountants, investment bankers, or other professionals (collectively, ‘Buyer’s Advisors’) may be retained for the sole purpose of assisting Buyer in determining the feasibility of entering into a transaction.”

The Buyer must inform any employee or advisor that that person is bound by the terms of the confidentiality agreement.

Discussing the deal in public

I’m constantly amazed at what I overhear in restaurants, on airplanes, in elevators, and other places where people gather. I constantly overhear people talking about lawsuits, tax cases, criminal cases, health problems, their troubled kids, and of course, M&A transactions. More often than not, these conversations use the actual names of the individuals or the companies involved!

Of course, yapping about such sensitive information is a no-no. You never know who’s sitting at the table next to you. That professional intently working the crossword puzzle (in ink, thank you) while awaiting his soup may be getting an earful of private, confidential, and sensitive conversation. It happens.

Instead of using specific names, I strongly suggest M&A deal-makers take a wiseguy approach to talking about sensitive material. Watch Goodfellas or The Sopranos for guidance. Here’s an example of this cloak-and-dagger approach:

Deal-maker 1: “Did you talk to that guy about that thing? You know, our friend in Columbus, did you take care of that thing with that guy?”

Deal-maker 2: “Oh, yeah, don’t worry, he won’t be a problem anymore. I took care of it; we had a real nice chat the other day.”

See how that works? Liberal use of “that guy,” “our friend,” and “that thing” goes a long way to help keep things under wraps. If you need to clarify, mention the city (“our friend in Seattle”) or mention the type of business (“that guy in the apparel distribution business in Lexington”).