While it’s aspirational only to do business with people in which their word or handshake is adequate assurance, when you’re working on a merger, acquisition, private financing, or other meaningful corporate transaction, you must ensure that you get everything important in writing. Over the course of a private M&A transaction, there will be numerous documents produced and executed, but the one that typically starts the process is a non-disclosure agreement (NDA), also known as a confidentiality agreement (CA). If you’re selling your business, the NDA is designed to enforce confidentiality among buyers, as well as define terms of engagement, limit what can be disclosed to third parties, and dictate other terms to which counterparties must agree.
Why Use an NDA?
NDAs are legal documents, designed to protect confidential information from being disclosed to a third party, or being negatively used against the party disclosing the information—often a private business. Therefore, having an NDA in place makes good business sense. As a business owner or CEO considering the sale of your business, you will need to consider how and when to use an NDA to protect your company. Perhaps a private equity group has recently approached you to discuss the possibility of selling your company, even though your business is not for sale at the present time. Or perhaps a competitor at a trade show spoke to you about forming a joint venture. It’s important that when these situations emerge you have a basic understanding of NDAs, their key elements, and how to use them to protect yourself and your business. Of course, you should always seek the advice of professional counsel when writing or structuring an NDA. This article only scratches the surface.
One-Way vs. Mutual NDAs
NDAs can typically be structured in two formats: a one-way NDA or a mutual NDA. In a one-way NDA, also known as a unilateral NDA, the receiving party of the confidential information is bound to protect such information. For example, if you have been approached by a private equity group, you could require them to sign a one-way NDA; doing so would protect any confidential information you disclose to the private equity group, but you would not be bound if the private equity group disclosed confidential information to you. You can think of a one-way NDA as protecting your information, but not the information of the other party. By contrast, if a competitor approached you at a trade show, they may insist that you sign a mutual NDA. In this case, any confidential information that you disclose, and any confidential information that the competitor discloses, is protected by the NDA.
Define Confidential Information
The above paragraph mentions several times the phrase “confidential information.” You may ask yourself: “what constitutes confidential information?” It’s an excellent question and the answer is different in many cases, as defined by the NDA in force. But in general, a proper NDA should clearly define what is considered confidential information, and furthermore, what is NOT considered confidential information. Never sign an NDA that does not specifically indicate what is considered confidential information, as you don’t want the courts to interpret the definition for you. Usually an NDA defines that any information relating to products, services, markets, customers, research, software, developments, inventions, designs, drawings, financials, and other items, is to be kept confidential. Exclusions to confidential information may include information already in possession of the receiving party or information that is in the public domain and can be proven to be public. If you plan to use an NDA that does not contain exclusions of what is not confidential, don’t be surprised if the counter-party sends you a revised or marked-up NDA including it.
Define The Term of The NDA
Another key element to negotiate in an NDA is the ‘Term’ of the agreement. You can think of the term as how long the confidential information will be protected. If you, as a business owner, are using an NDA without a term, you should expect the other party to insert a term in the agreement, often one to three years in length, depending on the nature of the transaction and market conditions. This is often where a disconnect occurs between buyers of companies and business owners. A business owner desires to protect his or her information as long as possible. A buyer, on the other hand, will not want to be bound by an NDA for an indefinite amount of time as it creates an ongoing obligation with no end. Think of it this way: would you sign a contract that restricted your actions forever? Not a chance. Don’t expect the same from a potential buyer of your business. Now, as a compromise, a business owner may decide that a five year term is appropriate. Unfortunately, the majority of buyers will not agree to a five year term. At most, a buyer may be willing to sign a three year term, but don’t be surprised if three years isn’t doable with some parties.
There are other important elements which are common in NDAs, which include but are not limited to:
- Purpose of Disclosing Confidential Information: states the specific purpose for which confidential information has been disclosed
- Returning or Destroying Confidential Information: defines how information is to be returned or destroyed and under what circumstances
- Use of Confidential Information: clarifies that information is not to be used for any purpose other than what was set forth explicitly in the agreement
- Enforceability of Entire Agreement: if one section of the agreement were to be found void, the remainder of the agreement survives and is enforceable
- Ownership of Confidential Information: states which party owns the confidential information