How Sellers Protect Confidentiality in M&A

This post explains how confidentiality works in M&A deals. Confidentiality is important in M&A deals, particularly from the seller's perspective. This post will look at why confidentiality is important to the seller and the documents that typically serve to protect it. We'll look at the M&A process from the perspective of confidentiality.

Why Confidentiality Matters

Here we'll look at the M&A (mergers and acquisitions) process from the seller's perspective. Generally, the seller is more concerned with confidentiality than the prospective buyer and this section will explain why.

When a business owner decides to sell, there are a number of reasons to keep this a secret. Here are some potential negative side effects of this information getting out prematurely.

First, the seller fears that their key employees could become apprehensive about their job security and start looking for new jobs elsewhere. This would impact the business very negatively from an operations standpoint, but it would also likely kill any potential deals on the table. Why? The new owners need the old employees to stay on post-acquisition to manage and run the business.

Another fear that sellers have is that large, or important customers could get nervous about this change in ownership and choose not to renew their accounts when their contracts expire. This may be the case especially if the owner of the business has built long-term personal relationships with these customers. Occasionally, a reason why these accounts have chosen the seller's business over their competitors (especially in the case of a small business) is their relationship with the owner.

Irrespective of size, the sale could be perceived negatively with many customer accounts in general. This has been the case with businesses in the fashion industry in the past. When a beloved brand is bought by a financial buyer that shifts their concern from being trendy to reliable cash flow.

If the business has a local presence there is often a fear that the local community will see the sale as a negative and a potential seller could be worried about the impact on their personal lives..

A huge fear is that confidential information may get leaked and find its way to a competitor. Customer lists, trade secrets, financial information, contract expiration dates, and supplier lists are normally things that business owners don't want their competitors to see.

Additionally, insights into research and development efforts could be exposed before the business has been able to monetize them. It often costs a lot to develop innovative products and often many months or many years are put into projects before they are ready to be advertised and sold to the public.

Another fear is that suppliers could see this as an opportunity to renegotiate a contract (or accounts payable terms.)

Regardless of the specific reasons why a seller would want to keep the fact that their business is for sale a secret, it's important to understand how the M&A process works from a confidentiality standpoint.

M&A Professionals That Can Help

Most of the time when a business owner decides to sell, they are intimidated by the process. This is often because the process of selling a business is entirely new to them.

Your chances of success are greatly increased by working with the right professionals and by learning as much about the M&A process as possible before you make any major moves to sell a business.

To begin with, it's always important to consult with an accountant and a lawyer before you try and sell. You want to speak with an accountant as early as possible so they can advise you on taxation. You want to be able to write off as many of the expenses associated with this sale as possible, and how you structure the deal will impact how it is taxed. Speak with an accountant before you need them.

Lawyers are important in this process as well. You will need them to help you understand all of the documents in an M&A deal. Speaking with an attorney early on is beneficial because they are your best consultants when it comes to figuring out what should be kept confidential in the first place. An important document to understand regarding confidentiality is the NDA (non-disclosure agreement) and you can learn more about their use and practice in M&A here.

Perhaps the most important professionals in the M&A process are the intermediaries the seller uses to facilitate the sale. These intermediaries act as middlemen between the buyer and seller. When the seller decides to sell, they will help them to prepare the documents we will talk about next.

Before we look at the documents that protect confidentiality in the M&A process, we'll look at the different types of intermediaries in M&A. Both the size of the business for sale and the type of exit strategy the seller is looking to use will impact their decision in who to choose to represent them. There are three main categories of intermediaries in M&A: investment banks, M&A firms, and business brokers.

First, we have investment banks. These are normally the best option if the business for sale is doing more than $100 million in revenue, or if the owner is looking to exit via an IPO (initial public offering).

Second, we have M&A firms. These firms are smaller than investment banks and don't have the other departments that investment banks do. In other words, all they do is M&A. These are normally the best option for businesses in the middle market doing between $5 million and $100 million in revenue.

Third, we have business brokers. These professionals are experts in facilitating the sale of small businesses. These are probably the best option for small businesses doing less than $5 million in revenue, but may also be a good option for businesses doing up to $10 million in revenue.

These revenue ranges are not set in stone, and naturally, there will be some overlap with the price ranges, but they serve as good guidelines. This is mainly important because they will have more than one or two working relationships with prospective buyers that can afford to buy your business. In order to get the best deal possible for the seller, we need to draw in more than one offer so the buyers drive the price up by making competing offers.

How Confidentiality Is Protected In M&A Deals

The intermediaries themselves are important for protecting confidentiality. By going through one of these intermediaries, the seller doesn't need to approach prospective buyers themselves. The intermediary acts as the middleman and keeps the seller out of the process at this stage.

The teaser is another way confidentiality is protected in M&A. This is the document that intermediaries will approach sellers with. It's a short document (a few pages) that gives high-level information about the business but keeps the seller's identity a secret. The idea here is that we don't need to give the prospective buyer any information about you or your business if they aren't interested in the key takeaways the teaser gives them.

If the prospective buyer is interested, based on what they read in the teaser, they will sign a non-disclosure agreement, agreeing to keep what they learn secret. This NDA is important, but the teaser is useful beforehand because the information has a way of leaking out if too many people are privy to it.

In exchange for signing the NDA, they will receive a more detailed information packet about the business. This is known as a confidential information memorandum (or CIM for short). The CIM aims to give prospective buyers much more detailed information about the seller's business, as well as more detailed financial statements. It also omits trade secrets (like active ingredients in pharmaceuticals) for additional security. This guide here is an excellent way to learn more about the CIM.

With the CIM, the prospective buyer will have enough information to do a valuation of the business. if this is a privately held business, the most common methods of valuation are discounted cash flow (DCF), comparable company analysis, and precedent transaction analysis. From there, negotiations can begin.

Summary

So, in summary, confidentiality is protected through the use of professional intermediaries, and a number of documents, including the teaser, non-disclosure agreements, and confidential information memorandums. These measures help to protect the seller's identity and give them peace of mind with the decision to sell their business.