The Importance of a Business Sale Non Disclosure Agreement (or NDA)

In this post you will learn:

• the purpose of an NDA when selling a business
• what could happen if an NDA is not signed
• when the NDA is effective and helpful to a business owner
• the types of information covered in the NDA
• what is typically excluded from the NDA; and
• why an NDA is a vital, first-step when selling a business.

A typical business owner invests a tremendous amount of time, effort and money in building a business.

It is extremely important for a business owner to make sure employees and third parties who work with the business are prohibited from improperly using or disclosing any confidential or proprietary information of the business(e.g. customer lists, trade secrets and financial statements).

Similarly, and in connection with the opportunity to sell a business, it is critical for the owner of the business not to provide any confidential information to a prospective purchaser until that party has signed a well-written business sale non disclosure agreement (also known as the NDA).

This type of legal agreement when selling a business should be the first line of defense for the disclosing party. They are designed to protect one of the most valuable assets of a business — proprietary information.

Non-Disclosure agreements are used for many different purposes (e.g. engaging employees and independent contractors, and negotiating a contract such as a supply and distribution agreement). However, this article focuses on the use of a business owner’s non disclosure agreement  in connection with selling a business.

Absent a signed NDA, a potential buyer of a business (the receiving party) has no legal obligation to refrain from using or disclosing the valuable proprietary information of that business. Simply marking documents “confidential” will not cause third parties to be subject to a duty of confidentiality in respect of those documents. Without this type of agreement in place, a potential buyer can use confidential information in a competing business, or share that information with competitors and others.

The NDA needs to be very broad in its reach to ensure that it captures the many different types of confidential information of a business. The term “confidential information” should be broadly defined in the agreement to include all information or data of a business (regardless of its form or media) including oral, electronic media and print that is disclosed by, or on behalf of, a potential seller to a potential buyer on or after the date the parties sign the confidentiality agreement.

When selling a business, the non disclosure agreement will not protect information that a seller provides to a potential buyer before the date the confidentiality agreement is signed. It is therefore important for a seller to have a signed confidentiality agreement in place before that person provides any information to a potential buyer.

Sample Types of Confidential Information in a Business Sale Non Disclosure Agreement

While the scope of what is considered confidential information can vary, the following information and documentation of a business should be protected under a non disclosure agreement:

• Any reports, computations, business plans, memoranda or summaries regarding the company, including notes and analyses that contain both technical and non-technical information;
• Trade secrets, proprietary information, methods, ideas, concepts, designs, inventions, know-how, processes, flow diagrams, operating procedures and instructions;
• Computer or software programs, software source documents, source codes, object codes and schematics;
• Information or formulas related to the current, future and proposed products and services of the company, including any research, experimental work, development, design details, specifications, samples, designs and models;
• Contracts (whether drafts or executed), financial records, accounting records, financial statements, forecasts, projections, budgets, and business, strategic or marketing plans;
• Current or prospective client and customer lists, vendor information, marketing research and details on business relationships;
• Sales data, sales analysis, prices, cost or profit figures, sources of supplies and pricing methods;
• Information about the personnel, real estate, equipment, and other tangible and intangible assets of a business; and
• Information or data included or reflected in any analyses, compilations, forecasts, studies, memoranda, notes or other working papers prepared by the potential buyer or its representatives.

Confidentiality Agreement Exclusions

When selling a business, the seller should require that all information it discloses to a potential buyer be kept confidential unless it falls into one of the following categories of information that are typically excluded from the definition of “confidential information”:

(1) any information that is already known to the public at the time that it is communicated to the potential buyer,

(2) information that becomes publicly known after the seller discloses it to the potential buyer (other than through the fault of the potential buyer or its representatives) or

(3) information that is required to be disclosed by law or a court of competent jurisdiction. In regard to information that is required to be disclosed by law, the potential buyer should first notify the seller that a disclosure has been requested, and the buyer should have the right to participate with the seller in determining the amount and type of confidential information, if any, that must be disclosed in order to comply with the applicable law.

Why You Should Always Insist Your Buyer Signs the NDA

In addition to protecting the confidential information of a business, an non disclosure agreement should also prohibit the buyer from making disclosures regarding the potential transaction itself. More specifically, the buyer should not be permitted to disclose to third parties any of the terms, conditions or other facts related to the discussions or negotiations between the parties.

The entrepreneur’s confidentiality agreement should also make clear that the buyer is only permitted to use the seller’s confidential information for purposes of evaluating the viability of the potential transaction.

Additionally, the buyer should only be permitted to provide the seller’s confidential information to those parties who need the information to evaluate the potential transaction and have agreed to be bound by the confidentiality agreement. If the buyer violates or threatens to violate any of its obligations under the confidentiality agreement, then the agreement should provide the seller with the right to obtain an injunction to prevent the buyer’s improper dissemination or use of the seller’s confidential information. Furthermore, if the negotiations between the parties break down, the buyer should be required to promptly return to the seller any confidential information the buyer has in its possession.

On occasion, a potential buyer may be reluctant to sign an non disclosure agreement, especially in cases where the buyer is either considering the purchase of a competing business or is conducting research and development in the same industry in which the target business is engaged.

Providing any confidential information without an NDA in place is extremely risky for the seller, and in such cases the seller should only disclose to the buyer such information that truly is not confidential in nature. The potential buyer may ultimately sign the NDA once the negotiations have progressed to the point that it becomes critical for the buyer to analyze the seller’s confidential information.

A sophisticated buyer will understand the need to execute a business owner’s NDA that prevents the buyer from using or disclosing the seller’s confidential information. This confidential information is a very valuable asset of the seller’s business, and, while the buyer needs to evaluate such information, it is critical that this information is not disclosed by the buyer to third parties or used by the buyer for any purpose other than evaluating the seller’s business in connection with a potential transaction.