Every successful business has a secret sauce that gives it an edge over the rest of its competitors. Companies take regular steps to ensure that their confidential information remains a secret and doesn’t get leaked to outsiders. However, when you are selling your business, you may have to disclose confidential information to parties that are interested in purchasing your business.
In addition to guarding company secrets, some private companies may even want to hide the news from their stakeholders, customers, staff, and the public out of the fear of destabilizing the business. It can be difficult to keep your business information confidential at the time of selling it. After all, the interested parties will want to know all about the business before they purchase it including its unique selling points.
This is where Non-Disclosure Agreements or NDA comes in. An NDA can be helpful in keeping your business information confidential, even when you have to share it with other parties during the selling process. If you want to know what this agreement is all about and how you can create one for your own business selling process, then keep reading. Because this article will explain how you can keep your business confidential when selling it with the help of an NDA.
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What is a Non Disclosure Agreement?
The idea behind a Non Disclosure Agreement is pretty straightforward. When a party signs an NDA with you, they are agreeing that they will not disclose any of the information about your business to outsiders or other parties. For this reason, an NDA may also be referred to as a confidentiality agreement.
An NDA is not a requirement, however, they are almost always a part of the business selling process before two parties enter negotiations. This agreement makes sure that any information that is disclosed during the negotiations phase can not be shared with other individuals.
NDAs are legally binding, and going against the terms of an NDA can have consequences. So if the party or parties that sign an NDA with a business prior to the negotiations process leak the confidential information to outsiders, there can be severe financial penalties for their actions. Not to mention the loss of reputation that comes with violating an NDA is another reason why these agreements have become a great way to protect the intellectual property of a business.
What are the types of NDAs?
Nondisclosure agreements are created for the protection of specific types of data, so in general, each company will have to add terms that best protect their intellectual property. With that said, NDAs in general are categorized into two categories, unilateral and mutual NDAs. Here are the differences between the two types of non-disclosure agreements.
A unilateral NDA usually means that one party is being bound to keep the details about a business confidential. Most NDAs between buyers and sellers during acquisitions are unilateral since the buyer is the receiving party and therefore has to make sure they don’t leak out the information they obtained from the disclosing party, which is the seller. A unilateral NDA is also commonly used when a vendor or employee needs to make an agreement with the employers regarding keeping the information they learned confidential.
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A mutual NDA is a complete opposite of a unilateral NDA because these types of NDAs bind both parties involved to maintain the confidentiality of the business. Mutual NDAs are less common in acquisitions, however, they are mostly used for mergers where both parties have some intellectual property they want to protect.
However, since acquisitions involve the seller sharing the information with the buyer the mutual NDA model doesn’t always apply to the business selling process. Though both may want to keep the negotiations secret.
NDAs are not just meant to be used during merger and acquisition deals. They are a key part of any negotiation of a business deal, and therefore it is essential for business owners to know what an NDA consists of. And that is exactly what we will explain in the next section.
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Terms to know before creating an NDA?
Just like any other legal document, an NDA contains some terms that you should know about before you use it. If you don’t have a legal team handling all the paperwork on your behalf, it is best to know what an NDA contains to better protect your business. With that said, here are some terms that are key components of an NDA that you should be familiar with:
Parties are the entities involved in an NDA, and the parties are usually classified as the receiving party and the disclosing party. The receiving party in an NDA is the one that is going to receive the confidential information, and the disclosing party is the one that will be sharing the information. When you are selling a business and want to protect the confidential information regarding your company, you will be the disclosing party and the buyer will be the receiving party.
Confidentiality is a term used to define the information that is protected under the NDA. In general, any data, or information that is shared physically or through digital mediums during the acquisition should be considered confidential.
It is common practice to mark certain documents as confidential when sharing them with the receiving party under the NDA. However, it is best to add a clause in the NDA that considers all of the documents being shared between parties as confidential.
Exceptions to confidentiality
Confidentiality may or may not cover all of the information being shared during the negotiations or selling process. When the seller wants to exclude certain information from what is considered confidential during the deal they can use exceptions to confidentiality in order to do so. Some information that is commonly marked as exceptions to confidentiality in an NDA include:
- Information about the company that is already public.
- Any information that has already been disclosed to the receiving party prior to signing the NDA.
- Any information that the receiving party received from a third party who was not bound to keep it confidential.
Disclosure of information
Since selling a business is at its core a transaction, it needs to be verified through certain sources. The only way to verify a transaction is by sharing the relevant information about the transaction. That is where disclosure of information comes in. This term defines any individuals or parties who can receive confidential information. The receiving party can make an exception when sharing information with them as long as these parties are identified in the NDA. Usually, the disclosure of information means that receiver can share the information with lawyers, investment bankers, and advisors.
Destruction of materials
As mentioned above, there is a high chance that negotiation doesn’t end in the selling of a business. So the disclosing party has to make sure that any information they have already shared with the receiving party during negotiations gets destroyed so that it doesn’t remain a threat to the confidentiality of a business. That is where the destruction of materials comes in and the disclosing party can add this clause to the NDA that bounds the receiving party to destroy any materials shared with them in case the negotiations are not successful.
Period of enforcement
A signed NDA when selling a business is only enforceable for a certain period of time. That is because acquisitions don’t last a lifetime so the period of enforcement of an NDA is usually around one or two years before it gets terminated.
Buyers might not be interested in signing an NDA if it is enforceable for a long period of time. So, setting a realistic enforcement period encourages buyers to get in an NDA before starting the negotiations process. The time after which the NDA becomes non-enforceable is also called termination of confidentiality.
NDAs are recognized by law, so when an NDA is being enforced it is important to specify what state body will govern the agreement.
Penalties for going against the terms of NDA
Last but not least an NDA must specify the implications of going against the terms of the agreement. This allows the disclosing party to go for legal action against the receiving party in case of a breach of confidentiality.
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How do NDA agreements work?
By now, you should understand that an NDA is there to protect the intellectual property of a business during the selling process. A lot of the time business owners get confused about how exactly an NDA can keep their business details confidential when they have to share them with potential buyers. However, it makes sense that the buyers will be interested in knowing the key operational matters, financial details, and overall performance of a business before buying it.
However, there is always a risk that the buyer may just be a competitor who is interested in finding out the unique selling point of your business so they can apply it to their own business. Therefore, sellers turn towards NDAs to make sure they have legal protection against their business’s confidential data being leaked during the selling process. In order to understand how exactly an NDA agreement works, we will consider an example of a hypothetical clothing manufacturer who is going through the selling process.
Negotiations for XYZ Clothing Brand
- An XYZ clothing brand specializes in creating and selling clothes catered towards senior citizens.
- The brand has a unique selling point in its production process that makes them a valuable company.
- The XYZ clothing company decides to benefit from the performance of their business and sell it for a good amount of money.
- When XYZ advertises their acquisition, they get contacted by a potential buyer who is interested in finding out about the unique manufacturing process that the clothing brand follows for producing the clothing.
- XYZ discloses all their confidential information including the manufacturing process to the potential buyer however the negotiations come to an end and the buyer backs off from the deal.
- The potential buyer then uses the information they learned about the XYZ clothing brand’s manufacturing process and applies it to their own business and starts making equally good clothes for seniors.
- Since no NDA agreement was signed between XYZ and the potential buyer, the XYZ brand may walk away with the secret manufacturing practices of the XYZ clothing brand.
Negotiating with an NDA
Now consider the same example of the XYZ brand but bring the NDA into the mix. If XYZ makes the potential buyer sign an NDA before disclosing all the information required for negotiations, the potential buyer is bound to keep the information a secret. Not to mention, they can’t use the information they learned about XYZ for their own benefit.
This example is a highly simplified version of how NDA works in real-life acquisitions. There can be any number of sensitive details that need to be disclosed during the acquisition process. Sometimes the seller may simply want to keep the news about the acquisition a secret because it may lead the investors to think that the company is unstable.
So no matter the size or value of your business there is always going to be sharing of sensitive data involved if you plan on selling it. And if you want to keep your business secrets intact then signing an NDA with each and every potential buyer is going to keep your business’s intellectual property safe.
Non-disclosure agreements allow sellers to safely negotiate with potential buyers without the risk of getting their intellectual property stolen. Or at least to be compensated for breaches. The penalties of breaking an NDA agreement may reach from a few thousand dollars to billions. It’s also worth mentioning that if a party breaks the NDA, they may also have to cover the legal fees that the seller had to pay during the legal proceedings.
Sellers can ensure they don’t walk away with less than they bargained for if they take the time to thoroughly construct an NDA before entering the negotiating process.
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