Confidentiality and Disclosure When Selling a Business.

April 18, 2017

One of the most significant differences between selling a going concern business and a commercial property is the seller’s need for confidentiality during the marketing process. There are many reasons a business owner would want to maintain confidentiality but a few key ones are:

1. Staff morale. An open sale process could affect employee morale and workplace atmosphere. Key persons, management and employees will emotionally invest in the process which can be a substantial distraction from the normal course of business.
2. Competitive advantages. Competitors, vendors and industry players could use the uncertainty created by the sale to change credit terms, recruit key employees or try to solicit the customer base.
3. Customer loyalty. Business owners sell for a variety of reasons: health, retirement, boredom or personal issues among others. No matter the reason, long term or loyal customers might feel disappointed or even betrayed that an owner “wants out” or fear that under new ownership the business may drift from its core values or operating principles. This could result in customers taking their business elsewhere or using the change of ownership to price out other service or product providers.

Keeping the sale confidential greatly reduces the chances of these situation occurring, but at some point, an owner will need to disclose the sale to employees, vendors, customers and clients. This disclosure is usually driven by in-depth due diligence by the buyer(s) who need to interview key people and put processes in place for the transition prior to the closing. This can be a delicate point—balancing the needs of the buyer to put the deal together with the needs of the seller to maintain confidentiality until the deal is a “sure thing.”  A business owner won’t want to give casual inquirers access to their employees, vendors and workplace until there is a solid agreement in place. Even a Letter of Intent may have enough due diligence contingencies that a buyer isn’t really locked into a deal at all.

So how do buyers and sellers negotiate this part of the process? There is no single formula for every transaction; it can change due to deal size, trust between parties, third party financing criteria, and the complexity of the business but there are a few strategies that can help.

1. Execute a comprehensive LOI or Term Sheet. The more details agreed to the in the LOI, the less chance of derailing the deal later during the Purchase & Sale Agreement process. Price, terms, strict contingencies, allocation and even monetary and duration limits on Representations & Warranties can be agreed to prior to in depth due diligence and disclosure.
2. Agreement to disclosure. The buyer and seller should discuss disclosure after agreement to terms. Who, if any, employees, clients or suppliers need to be contacted by the buyer as part of due diligence? The seller will want to err on the side of caution, but the buyer will want assurances that there won’t be a material impact on the business with a loss of a key employee, customer or supplier.
3. Benchmarked good faith deposit. A significant good faith deposit should be required as a sign of commitment from the buyer. Additionally, the deposit can be tied to buyer performance with portions of the deposit becoming non-refundable as those benchmarks are met. Typical benchmarks might be the “Exclusive Dealings” period, satisfaction of due diligence, receipt of 3rd party financing commitments, delivery of draft P&S, disclosure to key stakeholders and/or execution of the P&S.
4. Non-Disclosure Agreements. Confidentiality agreements signed at the start of the process should have non-solicitation clauses and clear rules for contact between the buyer and the seller’s employees, customers and trade relationships.

Having experienced legal representation and a knowledgeable intermediary can be invaluable when navigating the disclosure process, but no matter the size of the business or the sophistication of the buyers or sellers, many deals begin with a basic level of trust and respect. Sellers expect real intent and effort on the part of the buyer, and the buyer expects forthright disclosure of basic facts to assess the opportunity.