Why is a Confidentiality Agreement indispensable?

As a business owner, you have probably invested substantial amounts of time and resources in building your business. When it comes time to sell that business, steps must be taken to protect against anyone improperly using or disclosing any confidential or proprietary information of your business to others. Such information can take the form of customer lists, trade secrets and financial records, etc. For this reason, you need the protection of a confidentiality agreement before providing such information to a prospective purchaser.

In the absence of a signed confidentiality agreement, a potential business buyer has no legal obligation to refrain from disclosing or utilizing the valuable proprietary information of that business. Just because you consider or mark items you disclose in the business sale process as “confidential” will not cause third parties who learn about such information to be subject to a duty of confidentiality. You may have heard horror stories about a potential buyer of a business, with no confidentiality agreement in place, who uses the confidential information to start a competing business, or share that information with your competitors.

A confidentiality agreement 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 confidentiality agreement will not protect information that a seller provides to a potential buyer before the date the confidentiality agreement is signed. Thus it is important for a seller to have a signed confidentiality agreement in place BEFORE that person provides any information to a potential buyer.

While the scope of what is considered confidential information differs from business to business, at a minimum, the following information and documentation should be addressed in a confidentiality agreement:

  • Any reports, computations, analyses or methodologies concerning the business;
  • Current or prospective client and customer lists, vendor lists, 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.
  • Trade secrets, proprietary information, methods of doing business, ideas, concepts, designs, inventions, know-how, processes, flow diagrams, operating procedures and instructions;
  • Information 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, financial records and statements, tax and accounting records, forecasts, projections, budgets, and business, strategic or marketing plans; and
  • Computer and software programs, code, source documents and schematics.

Sellers of businesses should require that all disclosed information remain confidential unless it falls into one of the following categories of information that are typically excluded from the definition of “confidential information”: (1) 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 addition to protecting the confidential information of a business, a confidentiality agreement should also prohibit the buyer from making disclosures regarding the potential transaction itself or the conditions or other facts related to the discussions or negotiations between the parties. It could be devastating if word got out on the street that you were trying to sell your business.

A confidentiality agreement should also make clear that the buyer is only permitted to review the seller’s confidential information for the limited purposes of evaluating the viability of the proposed business purchase. Furthermore, it may be necessary to permit the buyer to provide the seller’s confidential information to parties who are helping it to evaluate the potential transaction and have likewise agreed to be bound by the terms of the confidentiality agreement.

To protect against the possibility that a potential buyer could violate its contractual obligations under the confidentiality agreement, then the agreement should provide the seller with the right to obtain an injunction in a court of law to block such unauthorized disclosure of the seller’s confidential information. Also, in the event the proposed sale never goes through, the agreement should require the proposed buyer to promptly return any confidential information the buyer has in its possession to the seller.

Occasionally, a prospective buyer is reluctant to sign a confidentiality agreement, especially in cases where the buyer is either considering the purchase of a competing business or is involved in the same industry as that of the seller. However, providing any confidential information without a confidentiality agreement in place can be extremely risky for 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 execute a confidentiality agreement once the negotiations have progressed to the point that it becomes critical for the buyer to analyze the seller’s confidential information. Any sophisticated buyer should understand the need to have a confidentiality agreement signed to prevent the misuse or unauthorized disclosure of a seller’s confidential information.

Keep in mind that confidential information could be the move valuable asset of the seller’s business. While the buyer needs to be able to evaluate such information, it is equally critical that the information not be misused or disclosed by the buyer to third parties or used for any purpose other than evaluating a potential transaction with the seller.

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