Confidentiality is generally much more critical to a business Seller than to a business buyer when selling a business in California.
Interestingly, when professionals such as landlords, lenders, escrow officers, accountants, and attorneys, with a reasonable amount of experience, are involved, they too come to understand its importance. However, when it involves a buyer or a new professional to the industry, it may not seem like a big deal. Yet, it can be critical for different reasons.
Why confidentiality is critical when selling a business
Confidentiality is critical for many reasons. The apparent reason is that a business Seller does not want key parts of their business to know they may be thinking of selling their business.
For example, if:
- A supplier finds out, they may change the current credit terms of the Seller, or indeed withdraw credit terms altogether.
- An employee, especially a key employee, discovers that they may be leaving and joining another employer, or worse still, a competitor.
- A landlord discovers this; they may cancel the lease, be unwilling to renew it, or, as I have seen, cancel the lease and instruct the Seller to vacate the premises so they can take over and run the business.
- Customers may start looking for a new business to meet their needs if they’re unsure about the new owner’s approachability.
What and when should a Seller disclose?
When a Seller shares information with a potential buyer, they are making representations. Representations are generally warranties and indemnities.
A warranty is generally a factual statement. A buyer wants to know that what a Seller says is true and accurate. Indemnities are a promise by the Seller to reimburse the buyer if a particular event occurs after the close of the sale that causes a loss to the buyer. These agreements are written in the Purchase or Sales Agreement.
To clarify, a Seller does not guarantee that if the buyer operates the business in the same manner as the Seller, they will achieve the same or better results. This is crucial information for buyers to consider when making their decision.
However, a buyer relies on the information the Seller discloses. This includes potential mistakes to avoid. If this information is inaccurate, it naturally exposes the Seller to legal action by the buyer.
Example
A buyer wants to see a set of financial statements to assess the business’s performance. Typically, a buyer wants to review this information for the last 3 to 5 full years of the business, and their preference is for tax returns, as the financial data is usually analyzed and corrected to roll up into the tax return.
Suppose the information is not accurate or presented in a format consistent with a set of financial statements. In that case, a buyer will not waste their time and will look further. This inaccuracy will concern them about what else is not being done acceptably.
As a key broker in California with over 19 years of experience, my typical process is to share the tax returns with the buyer only after an offer has been negotiated and accepted. I am, however, happy to summarize and share the information on the business’s performance.
I understand this is essential information a buyer needs to know. A tax return contains confidential information about the Seller’s business. Therefore, it does not need to be shared too easily.
Read More: Here is more information about the steps to sell a business to a strategic buyer in California.
Importance of a Confidentiality Agreement
To ensure the buyer receives all necessary information to make an informed decision and agrees to share that information only with the parties approved by the Seller, the buyer signs a Confidentiality Agreement. This is also known as a Non-Disclosure Agreement (NDA).
The Confidentiality Agreement is a written document. A verbal agreement would suffice, but a written document signed by the buyer is preferable. It will include the type of documents the buyer will receive and what ‘confidential’ means. Additionally, it explains how the information will be handled upon receipt, as well as other relevant conditions.
How should a Seller disclose?
A buyer typically wants a written document that includes all the necessary details. If only it were that easy. Buying a business is not a quick process, as it involves many steps over an extended period. To best protect the business and facilitate buyer inquiries, a one-page executive summary provides a concise overview of key information, helping buyers assess their interest in proceeding with the transaction.
My process involves providing a one-page executive summary to the buyer. This includes a Confidentiality Agreement for them to sign and return if they have further interest.
Once the Confidentiality Agreement is returned, I will then provide a Confidential Business Review. This document contains detailed information about the business.
Value of using a third-party professional
One of the values of having a third-party intermediary, such as a business broker in California, handle the transaction is that they will know what representations to make to a buyer, but more importantly, when.
A buyer wants to know everything about their first phone call. It is usually inappropriate to disclose the business name or its location until the buyer demonstrates their ability to purchase the business. Equally, they must agree to keep what is shared confidential to themselves and their professional advisors.
Even after a buyer signs a Confidentiality Agreement, it’s only appropriate to share certain information about the business. Some details will only be shared after the business sale closes. For example, a buyer may wish to see a list of customer, client, or patient names. However, this should only be disclosed after the sale closes.
Read More: Here is more information about how to value a business.
Confidentiality flows to the Purchase Agreement.
It’s essential to remember that once a buyer signs a Confidentiality Agreement, it should include the duration for which the information must remain confidential. This period is generally for a minimum of two years. The Seller does not want the buyer to share information for a substantial period. If the buyer breaches this part of the agreement, they will be subject to the penalties outlined in the Confidentiality Agreement.
Are you considering selling your business and taking on your next challenge? Would you like to know the value of your business? For more information, please visit my website, Business Valuation.
For more immediate help, you are welcome to send an email to Andrew Rogerson or give me a Call Toll-Free at (844) 414-9700