Confidentiality and selling a business
Confidentiality and selling a business is generally way more important to a business seller than a business buyer. Interestingly, when professionals are involved such as landlords, lenders, escrow officers, accountants and attorneys, if they have a reasonable amount of experience they too get its importance. However, when it involves a buyer or a new professional to an industry it may not seem such a big deal…but it can be critical for different reasons.
Why confidentiality is critical when selling a business
Confidentiality is critical for many reasons. The obvious reasons 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. If an employee finds out, especially a key employee, they may leave and go to another employer or worse still, a competitor. If a landlord finds out, they may cancel the lease, be unwilling to renew the lease or as I have seen done, cancel the lease and tell the seller to vacate the premises so they can take over and run the business. If customers start finding out, they may start looking for a new business to meet their needs as they may not be sure who the new owner will be and how approachable they are.
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 certain 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 be a little clearer, a seller is not guaranteeing that if the buyer buys the business and runs it the same way as the seller they will have the same or better results; which is what a buyer is looking to know so they can make their decision.
However, a buyer is relying on the information the seller is disclosing and if it’s inaccurate, it naturally exposes the seller to legal action by the buyer.
For example, a buyer wants to see a set of financial statements to show the performance of the business. A buyer typically wants to see this information for the last 3 to 5 full years of the business and their preference is tax returns as the financial data is normally analyzed and corrected to roll up into the tax return.
If the information is not accurate or presented in a format consistent with a set of financial statements, a buyer will not waste their time and look further as it will concern them about what else is not being done in an acceptable manner.
As a broker, my typical process is to only share the tax returns with the buyer after an offer has been negotiated and accepted. I am however, happy to summarize and share the information of the performance of the business as I understand this is important information a buyer needs to know. A tax return contains confidential information about the sellers business and does not need to be shared too easily.
Read More: Here is more information about the steps to sell a business.
Importance of a Confidentiality Agreement
To make sure the buyer receives all the information they need to make an informed decision and to make sure the buyer agrees to only share that information with the parties the seller approves, the buyer signs a Confidentiality Agreement also known as a Non-Disclosure Agreement or NDA.
The Confidentiality Agreement is a written document. A verbal agreement would work but a written document signed by the buyer is much better as it will include the type of documents the buyer will receive, what ‘confidential’ means and how the information will be handled when it is received as well as other conditions.
How should a seller disclose?
A buyer typically wants a written document that includes everything. If only it was that easy. Buying a business is not a quick process as it involves many steps and these steps are over an extended period of time. To best protect the business, the seller and to help handle buyer inquiries, a one page executive summary is a good way to provide some basic information so the buyer can decide if they have a genuine interest to move further into the transaction.
My process is to provide the one page executive summary to a buyer and also include a Confidentiality Agreement they can sign and return if they have further interest.
Once the Confidentiality Agreement is returned, I then provide a Confidential Business Review which is a document with 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 handle the transaction is that they will know what representations to make to a buyer but more importantly when. A buyer wants to know anything and everything with their first phone call. It’s normally inappropriate to provide the business name or even its location until the buyer shows they have the ability to buy the business and equally 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 as some details will only be shared after the sale of the business closes. For example, a buyer may wish to see a list of customer, client or patient names but 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 important to remember that once a buyer signs a Confidentiality Agreement it should include how long the information must remain confidential. This time period is generally for a minimum of two years as the seller does not want the buyer to share information for a good period of time. If the buyer breaches this part of the agreement they are exposed to the penalties that the Confidentiality Agreement will also explain.
Are you thinking about selling your business and move to your next challenge? Would you like to know the value of your business? If you would like 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 on 916 570-2674.
