Owners and managers of companies are legitimately concerned that the type of information disclosure necessary to consummate a transaction may put a company at serious competitive disadvantage if that information ends up in the wrong hands. Protection of a company that is pursuing a transaction (“Company”) essentially stems from four sources: (a) a Confidentiality or Non-Disclosure Agreement; (b) a deliberate strategy to delay transmission of sensitive information to bidders; (c) dealing only with reputable investors who would place their own reputation at risk in the event of a breach of confidentiality; and (d) not dealing with direct competitors, or even indirect competitors.
Most M&A practitioners have a healthy scepticism regarding the ability of confidentiality agreements alone to adequately protect the rights of their clients, given the difficulty of proving a breach in the first place and then the amount of damages. Moreover, the lack of jurisprudence and precedents in Central Europe on this subject make enforceability even more difficult, hence the need to rely on a combination of all four approaches.
(a) Confidentiality Agreements or Non-Disclosure Agreements
Most agreements cover only information received from the Company rather than information available from public sources. The duration is typically negotiable between one to five years, with two to three years being the norm. Generally speaking, boilerplate agreements do a poor job of properly representing the interests of the parties concerned; this is an agreement that requires careful thought and specific focus. One common flaw is that many confidentiality agreements do not state that the mere information that the Company is for sale, or is contemplating a transaction, is in and of itself confidential. Furthermore, companies typically try to stipulate liquidated damages (e.g. predefined damages if a breach of confidentiality is proven), whereas investors are typically reluctant to accept such damages.
(b) Delay in the transmission of information
There is a general principle that should be observed in these transactions: the volume and degree of confidential information transmitted by a Company should be in proportion to the degree of commitment given by an investor. For example, in the first stage of information disclosure (typically a Teaser or Information Summary), as there is no commitment from the investor usually there is not sufficient information to ascertain the identity of the Company (although there should be enough to allow the investor to decide whether or not to proceed further (e.g. sign a Confidentiality Agreement)).
Once a Confidentiality Agreement is signed, the Company typically provides investors with an Information Memorandum. Information Memoranda typically divulge a considerable amount of information about the Company, including its identity, key market and financial data, staffing, backlog of contracts, etc. In cases where certain information may be extremely sensitive (e.g. the identity of clients), the name or identity of clients is sometimes withheld and instead the Information Memorandum might refer to Client 1, Client 2, etc., with an understanding that the identity of clients, or other sensitive information, would be revealed at some stage before closing.
After the Information Memorandum is received, investors generally proceed to the next level of commitment which is to provide a non-binding offer. Once the parties agree to the terms of an offer (often finalized in a Term Sheet), the Company then allows access to the Data Room, where source documents such as contracts, title documents, intellectual property, etc. are made available. Once again, highly sensitive information may be withheld until prior to closing, bearing in mind that if such information is not according to the investor’s expectations, the investor will generally reserve the right to back out of the transaction. Withholding sensitive information may also hinder the bidder’s ability to nail down the purchase price and a sensible compromise must be found at this important stage.
After the Data Room, the investor then must decide whether to make a binding offer. After a binding offer, the parties usually negotiate a Sale and Purchase Agreement (SPA). After signing the SPA, the investor should then insist on receiving all the information about the Company, with absolutely nothing withheld. As a past client of ours stated when selling their business, “We had to dress down to our underwear, and beyond,” and, indeed, dressing down is the quid pro quo for the investor putting millions of dollars or Euros at risk.
(c) Deal with a reputable party
A Confidentiality Agreement, or indeed any other agreement, is usually not worth the paper it is written on unless signed by a reputable party. Given the difficulty of verification of any transgressions and proof of damages, a judgment call needs to be made about the character of the individual or corporate recipient and there must be mutual trust in order for a deal to work. This is of course especially true when providing sensitive information to a direct competitor and so the ethics and reputation of the firm in question are vitally important.
(d) Not dealing with direct or indirect competitors
Most business owners have a healthy reluctance to share information with competitors. The reluctance is stronger the more direct the potential competitive threat. If a business owner has other potential investors, he might choose to negotiate first with parties who do not pose a threat. Alternatively, once again, the release of sensitive information could be delayed. However, in doing so there is a tradeoff, in that this may also delay obtaining a bona fide offer.
Think of the process of information disclosure as a ritual or dance: step by step. Do not let one foot get too far ahead of the other!
Les Nemethy is the CEO of Euro-Phoenix Financial Advisors Ltd. (www.europhoenix.com), a Central European corporate finance company focused on Mergers & Acquisitions.